Discounts

DISCOUNTS

Discounts in contracts

Offering discounts to customers is normally justified when it results in higher overall profits. Even when a company has a shortage of cash, discounts can be granted in order to increase sales and cash inflows.

Discounts can be offered to encourage different types of customer behaviour

Encourage early payment of invoices
Encourage the purchase of higher volumes of goods
Promote the signing of a long-term contract
Promote a long-standing business relationship and acknowledge the value of the customer
Acknowledge a customer's superior creditworthiness
Acknowledge a customer's acceptance of lower or inconsistent quality products

All other things being equal, discounts for early payment are preferable to penalties for late payment

Higher revenues result in higher taxes, discounts lead to lower taxes.
As a practical matter, incentives generally work better than penalties.

Analysis of discounts

Discounts encourage early payment, but at a cost

Early payment by customers frees up cash that can then be invested or otherwise used in the business instead of being tied up in inventory or receivables

Thus, customers should be offered a discount to encourage early payment

However, the cost of the discount should not exceed the benefits from early payment

A discount scale can be developed which relates payment periods to discounts

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