What is Dynamic Discounting?
Monday, 5 Feb 2018
Senior Account Manager
Interest rates are still hovering at historically low levels, yet many companies are still using payment terms as a financial instrument to manage their funds. Invoices are either paid late, or payment terms are being extended in various markets, leaving suppliers in a precarious cash flow position.
Capital shortages can bring even healthy companies to their knees, so it’s not surprising that a study by Basware and MasterCard revealed that 82% of businesses would invest more in their organisation if all invoices were paid promptly.
Conventional vs dynamic early payment programmes
Early payment programmes are not new. Suppliers typically offer their customers a discount if invoices are paid before a specific date. For example, if the payment term is 30 days, a 2-3% discount may be applied if payment is made within 10 days. Often, however, this fails in practice simply because the invoice processing cycle is too long. With the introduction of e-invoicing and automated invoice processing, lead times can be significantly reduced, enabling companies to benefit from discounting if they wish.
More compelling, however, are early payment programmes based on dynamic discounting. “Dynamic” means that the early payment programme is on a sliding scale, which allows buyers to receive the maximum discount on approved invoices and a moderate discount on invoices paid a little later. Unlike conventional early payment programmes, there is the option to receive a cash discount on all incoming invoices paid before the due date.
Benefits for suppliers and buyers
The advantages for suppliers are obvious: cash flow is more important than big margins, especially for smaller suppliers, as it’s crucial to sustained business. But Dynamic Discounting is also beneficial to buyers: as well as providing a stable supply chain, dynamic discount management can support increased margins and growth.
For instance, a company pays a bill with a 30-day grace period after just 10 days in exchange for a 2% cash discount. So by investing that money for 20 days, it makes a profit of 2% of the invoice value. To calculate the actual value of the discount, the business needs to understand the cost of working capital – either the cost of borrowing or, for a cash-rich company, the opportunity cost of not investing cash, i.e. the interest it could have earned. Given today’s persistently low interest rates, the company could easily see a return of 36% (which, when annualised, can amount to a figure that will make any Treasury Manager sit up and take notice). If payment is made after 20 days with a 1% discount, the company still gets a return of approximately 33%. To see how this is calculated, check out this Purchasing Insight article.
How Dynamic Discounting works in practice
Suppliers and buyers connect with each other via online platforms, such as the Basware Commerce Network. Buyers can specify how much capital is available for early payments, and the level of return they wish to achieve. Once the discounts are agreed between buyer and supplier, they are automatically invoked when early payment is made. Buyers can choose to approve individual invoices for early payment, and suppliers can similarly request early payment for specific invoices.
Collaboration between buyers and suppliers via Dynamic Discounting platforms results in a fair, mutually beneficial outcome, and can strengthen the buyer-supplier relationship by promoting trust.
See how Basware can help you strengthen your supplier relationships with Dynamic Discounting and other financing services.
If you have any questions, or just want to talk through your options, you can get in touch via our contact us form.