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? 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 that is granted by a bank to a business when swapping for a bill of exchange. A trade bill, such as a bill of exchange or a 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 that are owed immediately. The bank then collects the receivable.

However, it is important to note that bank discounts come with a fee and that banks don't have to allow them. They analyse the associated risks before accepting (or rejecting) the discount request.

Commercial discounts

Commercial discounts are intended for customers and occur when a business offers them a discount. Commercial discounts are payment discounts – in other words, an option (offered by the supplier) to pay an invoice before the due date in exchange for a discount. Both parties benefit from this arrangement, with the customer receiving 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, startups cannot receive a cash discount because banks require a complete record of information about the business (financial structure, budget and legal documents).

With commercial discounts, customers only receive a discount 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 allows you to manage your cash flow in line with the discount.

Discounts are generally cheaper and easier to obtain from banks than overdrafts or loans. 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, fees are still involved. 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 between banks, 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 work out 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 *

For 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 the discounts allowed and the 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 have been 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 customers a discount. 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 no discount is applied, the invoice must state "Early payment discount: none". You can learn more about the information that is required on an invoice in our article covering this topic, or you can 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 customising 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.