What is an early payment discount?

Definition

An early payment discount is a price cut offered if the customer pays an invoice before the full due date. The seller takes a little less revenue in exchange for cash arriving sooner.

It is written into payment terms, not issued as its own bill. A common form is 2 percent off if the customer pays in 10 days, with the full amount still due later if they miss that window.

On the books, the discount reduces accounts receivable when it is taken. The offset is usually a sales discounts account that lowers net revenue.

Where it shows up

P&L: Related to the sales discount that reduces net revenue.

Balance Sheet: Related to the receivable dropping by the discount.

Cash flow: Related to cash arriving sooner, at the reduced amount.

See also: Payment Terms · Sales Discounts · Invoice

When you look at the Income Statement, you will not always see a line with this name. You will see lower net revenue, because the discount is a reduction of the original sale.

On the Balance Sheet, the receivable in current assets drops by the discount as well as by the cash that came in. The customer no longer owes the full invoice.

The Statement of Cash Flows shows operating cash arriving earlier than the full due date. The amount that arrives is the invoice minus the discount taken.

Days sales outstanding often improves when customers take the offer. They pay inside the short window instead of waiting until the full term.

On the vendor side, the same offer can appear on bills you receive. Taking it lowers what you pay, and days payable outstanding shortens because you sent cash early.

How it works

The seller prints the discount on the invoice, such as 2/10 net 30. That label means 2 percent off for paying within 10 days, and the full amount due in 30 days if the discount is skipped.

The original invoice still records the full sale and the full receivable. Nothing about the offer is journaled until the customer actually takes it.

When the customer pays inside the window, cash comes in at the reduced amount. The remaining slice of the receivable is cleared by debiting sales discounts and crediting accounts receivable.

That discount slice is the subject of this page. The cash receipt is a separate part of the same settlement.

If the customer misses the discount window, they owe the full invoice. No sales discount is recorded, and the due date stays the original net date.

The seller is trading margin for speed. A 2 percent cut for cash 20 days early is a real cost, so the offer only makes sense when that cash is needed sooner.

Example

A florist bills a cafe $1,000 for event flowers. The invoice offers 2 percent off if the cafe pays in 10 days.

The cafe pays on day 8 and takes the $20 discount. The florist records the discount slice this way:

Debit: Sales discounts $20

Credit: Accounts receivable $20

Sales discounts of $20 reduce net revenue. Accounts receivable drops by $20 for the slice that will never be collected as cash.

The cafe remits $980, not $1,000. That cash clears the rest of the receivable, and it is a separate collection from the discount entry above.

If the cafe had waited until day 30, the florist would have collected the full $1,000. No sales discount would have been recorded.

Common mix-ups

An early payment discount is not a credit memo. A credit memo lowers a bill because of returns or billing errors, and this discount is a planned price cut for paying fast.

An early payment discount is not a write-off. A write-off removes a balance you will not collect, and this cut is taken only because the customer did pay, just a little less.

An early payment discount is not the same as net 30. Net 30 is the full due date, and the discount is an optional shorter path printed next to it.

An early payment discount is not a late fee. One reduces the bill for paying early, and the other adds to the bill for paying late.

Related terms

• Payment Terms: The agreed deadline and conditions for paying an invoice.
• Sales Discounts: A contra-revenue account for price reductions and early-payment terms taken by customers.
• Net 30: Payment terms requiring the full invoice to be paid within thirty days.
• Days Sales Outstanding: The average number of days it takes to collect an invoice.
• Days Payable Outstanding: The average number of days the business takes to pay its vendors.
• Cash Flow Forecast: A forward projection of cash receipts and payments.
• Invoice: The document that bills a customer and creates a receivable.
• Vendor Bill: The invoice a supplier sends that becomes a payable.