In business-to-business (B2B) transactions, cash discounts are the easiest way to get paid before the due date. What is a cash discount? What calculation formula is used? And how do you record a cash discount in your accounts? You’ll find the answers to these questions and more below.

What’s in this article?

• What is a cash discount and what are the different types?
  
• What requirements must be met to qualify for a cash discount?
  
• What are the benefits of a cash discount?
  
• What are the disadvantages of a cash discount?
  
• How do you calculate a cash discount?
  
• How do you record a cash discount?
  
• Should you mention a cash discount on an invoice?
  

What is a cash discount and what are the different types?

Cash discounts are a short-term financing solution used for commercial transactions settled with a bill of exchange. There are two types: bank (or financial) discounts and commercial discounts (for early payment).

Bank discounts

Bank discounts are a cash advance granted by a bank to a business when swapping for a bill of exchange. A trade bill, such as a bill of exchange or promissory note, allows a customer to pay for purchases at a later date. To avoid waiting for the due date, the business can transfer the bill to the bank to receive the funds owed immediately. The bank then collects the receivable.

Note that bank discounts come with a fee and that banks don’t have to allow them. They analyze the associated risks before accepting (or rejecting) the discount request.

Commercial discounts

Commercial discounts are intended for customers, occurring when a business offers a discount to them. Commercial discounts are payment discounts—i.e., an option (offered by the supplier) to pay an invoice before the due date in exchange for a discount. Both parties benefit: the customer receives a price reduction, while the supplier collects the funds before the due date.

What requirements must be met to qualify for a cash discount?

Only professionals and businesses can receive bank discounts. Private customers are not eligible. In addition, start-ups cannot receive a cash discount because banks require a complete dossier of information about the business (financial structure, budget, and legal documents).

With commercial discounts, customers receive a discount only if the invoice is paid before the due date.

What are the benefits of a cash discount?

As a business, bank discounts allow you to obtain funding quickly without waiting for the due date. This lets you manage your cash flow in line with the discount.

Discounts are generally cheaper and easier to obtain from banks than overdrafts or loans are. With bank discounts, you don’t have to resort to external financing and your relationship with the customer remains intact.

With commercial discounts, the customer receives a price reduction while the supplier’s invoice is paid early.

What are the disadvantages of a cash discount?

Although bank discounts are less expensive than overdraft facilities, there are still fees involved. These bank charges may include fees for reviewing the file, initiating the discount, renewing it, processing it, or transferring it to the bank. When the discount is used, you will also incur interest based on the discount financed and the term. Some bank charges may also apply. The costs associated with cash discounts vary by bank, so it’s important to check with your bank to find out more.

In addition, the bank often limits the credit line. It must be negotiated each year, depending on your business’s financial health and other factors.

How do you calculate a cash discount?

To calculate the cost of a bank discount, you’ll need the following information: the bill of exchange price excluding value-added tax (VAT), the bank discount rate, and the number of days until the due date. The discount rate depends on the rates set by your bank.

Calculating the cost of a bank discount:

*Cost of Bank Discount = (Bill Price Excluding VAT x Discount Rate x Number of Days Discounted) ÷ 360 *

Consider this example: you discount your bill of exchange for €10,000 excluding VAT with a payment term of 60 days. The bank offers you a discount rate of 7%. The bank discount costs you €116.67.

(€10,000 x 0.07 x 60) ÷ 360 = €116.67

To find the amount of money that the bank will give you as an advance, simply subtract the discount cost from the price of the bill:

*€10,000 - €116.67 = €9,883.33 *

In the case of commercial discounts, the supplier determines the discount rate. Multiply the invoice price excluding VAT by the discount rate to determine the commercial discount allowed:

*Amount of Commercial Discount = Invoice Price Excluding VAT x Discount Rate *

With an invoice price of €10,000 excluding VAT and a discount rate of 4%, the customer receives a discount of €400:

*€10,000 x 0.04 = €400 *

How do you record a cash discount?

For accounting purposes, it’s important to distinguish between discounts allowed and discounts received. For commercial discounts, the supplier’s account 665 “Discounts allowed” is debited, while the customer’s account 765 “Discounts received” is credited.

Once bank discounts are allowed by the bank, the business must debit account 5114 “Discounted bills” and then credit account 411 “Customers.”

Should you mention a cash discount on an invoice?

You are not required to offer a discount to a customer. However, as a supplier, you must include the commercial discount (or lack thereof) on the invoice sent to the customer. The information required on the invoice includes the scheduled payment date and the discount terms for early payment. If there is no discount, the invoice must state “Early Payment Discount: None.” You can learn more about the required information on an invoice in our article on the subject, or visit the official French government website for a sample invoice for professionals.

You can also simplify your invoicing process with an automated invoicing solution such as Stripe Invoicing. This integrated tool speeds up the process of creating and customizing invoices with discounts, without writing code. To find out how you can streamline your accounting and invoice payment processes, contact one of our experts today.