Cash Discounts and Unearned Cash Discounts

A cash discount is a reduction in the price of an item allowed by the seller/creditor only if payment made by the customer is received within a stated number of days.  An example of a cash discount is the payment term: 1% 15 days, Net 30 days.  In this example, a customer will receive a 1% discount if payment is received by the seller within 15 days.  If not, payment in full is expected within 30 days from the date of invoice.  Sometimes, a customer will stop taking cash discounts offered for early payment. The most likely causes are:

(a) cash flow problems, or
(b) a change in personnel or workflow in the accounts payable department.

A credit professional should try to find out why the debtor stopped taking the early payment discount. This is not idle curiosity. A change in payment patterns could indicate a short-term cash flow problem, or be the first indication of a serious financial crisis.  A call or letter to the customer asking about the change in payments is appropriate. There is no reason to question the customer's financial health, ability to pay, willingness to pay, or future prospects. The initial inquiry should indicate only that the creditor is interested in the buyer's decision no longer to take the early payment discount.

If the decision not to discount is the result of a change in personnel or workflow, your call may result in the customer starting to discount again especially if you address your inquiry to the customer's accounting manager, controller or CFO. Why?  Management may have been unaware of the change in payment patttern, and could be anxious to take advantage of the cash discount offered. Industry practice frequently helps determine how large prompt payment will be, but generally speaking cash discounts are quite advantageous to the customer.

The credit department is responsible for the integrity of their cash discount program. Most creditors allow a few days grace period before charging back unearned discounts. Chargebacks of unearned discounts are often difficult and time consuming to collect.  In fact, it may seem at times that doing so is not worth the effort.   However, unless the credit department protests when customers take unearned discounts, the problem is likely to grow [meaning that customers will pay later and later and continue to take unearned discounts].

Some customers actually test its creditors to determine their sensitivity to unearned cash discounts and delays in payment. There is at least one software program available that allows an accounts payable department to track creditors' responses to late payments and unearned discounts in order to determine how many days they can delay payment without having the discount charged back. This information is added to the accounts payable notes and it becomes the basis on which payments are scheduled.  The best way to address abuse of your cash discount policy is to create hard and fast rules about charging back all discounts taken beyond the established grace period - and holding collectors accountable for recovering these unearned discounts. The goals of the credit department include:

• Recovering unearned cash discounts taken by customers
• Enforcing your prompt payment cash discount policy
• Reducing late payments and encouraging payment terms compliance by customers who continue to take cash discounts

© 2011.  Michael C. Dennis.  All Rights Reserved.   Mr. Dennis is a consultant and the author of "Credit and Collection Handbook."   He can be reached at mcdennis13@yahoo.com