Cash Discounts – Cash is King.
In the current business climate investors are moving away from fundamentals in evaluating a stock to a very detailed look at a firm’s balance sheet. One of the reasons for this paradigm shift is some companies are taking advantage of the allowance for bad debt to artificially inflate the company’s earnings. In doing so, the company’s fundamentals will continue to look strong when in actuality they have underestimated the amount of bad debt they are carrying in accounts receivable. Some businesses attempt to reduce the exposure to uncollectable debt by reducing the use of accounts receivable in general but there are cases when this is impossible. A predominate way of keeping accounts receivable to a manageable size is to offer cash discounts which benefit both the seller and buyer of a good or service.
A cash discount is a fixed percentage off of the cost of a good or service for prompt payment. For example if a painter provides a quote to paint a house for $1,000 but if the owner pays in cash at the time of service the painter will only charge $950. On the surface this situation gives the impression that the customer received a benefit from the cash discount in the amount of 5% of the quoted price but the painter received no such benefit. In fact the impression could be given that the cash discount was detrimental to the painter because the overall fee was reduced by $50. Digging deeper into the painters thought process benefits of the cash discount will become apparent. Firstly by receiving the payment in cash the painter does not have to worry about fees for a credit card transaction (2%-4%). Additionally the painter is then protected from charge backs and fraudulent credit cards due to identity theft. If the homeowner chose to finance the cost of the service then the painter would be exposed to the possibility of the homeowner not paying the debt. If this happens the painter would have to expend time in attempting to collect that debt or sell the debt to a collection agency at a loss. If the painter is paid cash at the time of transaction both of these scenarios are mitigated; there is no credit card fees to pay and there is no threat of a non paying customer.
Offering cash discounts is especially beneficial to small businesses because discounting the price of a good or service is outweighed by the overhead needed to collect on bad debts. A small business can still offer an accounts receivable function with a minimal staff to maintain it if a significant cash discount is offered. In larger organizations a full accounts receivable and collections staff is able to handle a sizable credit function, but by minimizing the risk of bad debt by offering cash discounts the company can focus on its core business while maintaining a lean accounts receivable staff.
Cash discounts are a great way to save money for the consumer as well as provide peace of mind to the seller. When the buyer has cash on hand to pay for a good or service quickly and the seller discounts the price for the prompt payment both parties win.