Early payment discount

What it means

A cash discount, or skonto, is a price reduction a supplier gives a customer for paying an invoice before the agreed due date. A typical term is, for example, two per cent off for payment within ten days, otherwise the full amount within thirty days.

For the supplier, a cash discount speeds up collection and improves cash flow; for the customer it is a way of cutting costs when it has spare cash. Converted to an annual rate, it is often better than a bank deposit or a loan to finance the payment.

For accounting and VAT, it is a retrospective discount that reduces the taxable amount. If the supplier invoiced the full amount with VAT and the customer took the discount, the difference is dealt with by a corrective invoice or credit note.

How it works in practice

For customers with surplus cash we regularly work out whether it pays to take suppliers’ cash discounts. Two per cent for paying twenty days early equates to an annual return of over thirty per cent, which no deposit will provide.

For suppliers offering cash discounts we set up invoicing so that the term is clearly stated on the invoice and a partial payment can be identified as a discount rather than an underpayment. Discounts taken are booked, and for VAT we issue a credit note.

The customer’s accounting treatment of cash discounts is set out in the accounting policy. For goods and materials still in stock, their acquisition cost is usually reduced; for services and consumed goods, the expense. Consistency from year to year is what matters.

What to watch out for

A discount taken after the deadline has no basis in the contract. If the customer pays the reduced amount late, the supplier can pursue the difference as an underpayment. With automated payment orders we therefore check that the discount is applied only on time.

For VAT, simply paying the lower amount is not enough. Without a corrective document the supplier has declared VAT on the full amount and the customer has deducted it on the full amount, which leads to mismatches in the control statement in an audit.