Early Payment Discounts? Why it is Not the Best Solution.

Delays in payments can create cash flow problems

Delays in customer payments can quickly create cash flow pressure for small businesses. Many business owners offer credit and 30-day trading terms to secure sales, yet customers often take longer to pay or, in some cases, fail to pay at all. For businesses that rely on regular cash flows, these delays can be difficult to absorb.

A business may appear successful on paper, with strong sales growth, but when customer collections lag behind day-to-day expenses, cash reserves begin to erode. While overheads such as wages, rent, and supplier payments must still be met, insufficient cash receipts from customers can leave the business struggling to fund its operations. This raises an important question: are early payment discounts really the solution to late payments, or do they simply mask a deeper problem in credit management?

Is the solution early payment discounts?

Experts in marketing suggest that offering early payment discounts can foster customer loyalty, while financial consultants advise that such incentives may expedite the receipt of payments.

Consider the issues before offering early payment discounts:

• Why are you giving the discount in the first place?

  • Is it being used as a substitute for effective debt collection because staff are uncomfortable chasing overdue invoices, rather than implementing a structure and consistent follow-up process?
  • Is it because the business cannot afford to carry a ledger of 30-day accounts which may indicate the need to reassess how many customers are granted credit and the size of the credit limits applied?
  • Or does the business lack clear policies and procedures designed to minimise the risk of customers delaying payment, or not paying at all.

Early payment discounts also reduce profit margins. In effect, the business is trading profitability for speed of payment. For example, with a profit margin of 10%, offering a 2% discount equates to giving away 20% of the profit on that sale. This is a significant cost, particularly if a large proportion of customers take advantage of the discount.

It is also worth questioning why all customers should receive an early payment discount when those who already pay on time would likely continue to do so without any incentive. In this situation, the discount provides no behavioural benefit, only an unnecessary reduction in revenue.

Finally, there is no guarantee that customers will pay early simply because a discount is offered. Customers can change their minds, and some may take the discount while still delaying payment. This negatively affects both cash flow and profitability and places the business in a difficult position. Following up the account may lead to confrontation, yet allowing the discount to stand effectively rewards poor payment behaviour.

In my opinion, customers should not be rewarded simply for paying their account. In most cases, you have already given them your best price, so offering an early payment discount only reduces your profit further, with no guarantee of improved payment behaviour.

If the objective is to receive payment sooner:

• a more effective approach is to reduce the number of days allowed to pay.
• Alternatively, apply shorter payment terms specifically to customers with a history of late payment, rather than penalising your business across the board.

If you choose to offer a discount, they are far more effective when used strategically:

• discounts can be offered when a customer refers a new client to your business,
• or when they spend more than a set dollar amount.

These types of incentives encourage growth and increased sales volume, rather than simply discounting revenue you would likely receive anyway.