Early Payment Discount

Early payment discounts enable suppliers to get paid faster, increasing cash flow.

Businesses have offered early payment discounts for years, but fintech companies such as C2FO are using a dynamic approach to make these discounts more flexible and cost-effective.

What is an early payment discount?

An early payment discount is a type of working capital financing where buyers pay suppliers earlier than the agreed payment term in exchange for a small discount. As a result, suppliers improve cash flow and access the working capital needed to operate consistently and make growth investments. Buyers benefit from a lower cost of goods or services and fewer supply chain disruptions.

Early payment discounts are different from invoice factoring and supply chain financing. Invoice factoring and supply chain financing both involve a third-party lender that funds early payment on behalf of the buyer, whereas early payment discounts are funded directly by the buyer without any third-party involvement. Invoice factoring includes additional fees, while discount rates are determined by the buyer’s lender in a supply chain financing program. With early payment discounts, the only cost to the supplier is the discount amount it sets. 

Early payment discount formula

There are two main ways that this concept is implemented:

  • Static discounting. The supplier extends a fixed discount offer to the buyer, usually expressed through an early payment discount formula, for example: “2/10 net 30.” In this example, the buyer has two options — pay within 10 days and receive a 2% discount, or pay the full amount within 30 days.
  • Dynamic discounting. The buyer makes outstanding invoices available for early payment through an online platform. The supplier selects which invoices to request early payment on and sets a discount rate. The buyer can accept discount offers at any time before the full term. If accepted, the platform automatically adjusts the buyer’s discount using an early payment discount calculator — the earlier the payment, the bigger the discount.

Dynamic discounting requires expressing a discount rate as an annual percentage rate (APR), which represents a yearly cost of funds. This allows dynamic discounting platforms to calculate the discount amount based on how early the buyer pays, dividing the APR by 365 and multiplying the result by the number of days paid early as well as the amount owed:

(APR% / 365) x (# of Days Paid Early) x Invoice Amount = Discount Amount

Dynamic discounting is a more recent approach to discounting, and it generally delivers a greater benefit to both parties than static discounts. Buyers have more flexibility when taking advantage of dynamic discounting because they can receive a discount at any time before the full payment term. It can also give suppliers a more affordable discount rate, as well as more control and predictability over early payment requests. Dynamic discounting solutions such as C2FO’s Early Payment program enable businesses to combine early payment discounts with other financing solutions to optimize working capital.

How it works in practice

Suppliers typically offer a static early payment discount as an extension of an invoice’s payment term. For example, imagine that a supplier needs to improve its cash flow by offering a discount to a buyer with terms of net 90. The supplier submits an invoice totaling $20,000 to the buyer with a 2/20, net 90 offer. This means that if the buyer pays within 20 days of receiving the invoice, it receives a 2% discount of $400 — otherwise, the full balance is due within 90 days. The supplier’s accounting team notices a $19,600 payment arrive from the buyer two weeks later, a few days before the early payment offer expires. 

The process for dynamic discounting looks a bit different. In this scenario, the supplier has a buyer that uploads approved invoices onto an early payment platform — for example, C2FO’s Early Payment program. The supplier logs in to the platform and selects an outstanding invoice totaling $20,000 for early payment, setting a target discount of 12% APR. The buyer accepts the discount and pays the invoice 32 days early. Using the dynamic discounting formula above, a 12% APR would translate to a 1.05% discount for the buyer, or $210.  

Why is this important?

Issues such as rising inflation, the longstanding economic impacts of COVID-19 and banking disruptions have prompted many buyers to extend payment terms, sometimes as long as 120 days or more. Even if suppliers make consistent sales, they may wait many weeks or months for invoices to clear accounts receivable. That can leave them without the cash required to keep a business running, deliver goods on time and in full, or invest in business growth.

Extended payment terms have forced many suppliers to seek working capital financing. However, traditional solutions such as business loans can be hard for small to mid-sized businesses to qualify for. And many options are expensive — especially as interest rates rise. Early payment discounts provide a more cost-effective and accessible working capital solution for small to mid-sized suppliers, helping them access the cash needed to operate and grow.

The advantages of early payment discounts

  • Increase cash flow. With dynamic discounting, suppliers can request early payments on demand and receive a cash flow injection when it’s needed most.
  • Reduce costs. Small to mid-sized suppliers can access working capital funding at a lower cost than traditional options, such as business loans from a bank.
  • Improve cash flow visibility. Dynamic discounting gives suppliers more control over early payment requests and offers more predictability for cash flow forecasting.
  • Strengthen buyer relationships. Suppliers secure the cash needed to grow and address increased customer demands while navigating longer payment terms.