6 Key Benefits of Using Dynamic Discounting to Get Paid Early
August 23, 2022 |
The C2FO Team
Businesses attempting to navigate inflation while maximizing cash flow can find themselves in a delicate balancing act. They need to maintain profitability despite rising costs, but they are also striving to be more efficient with working capital.
One of the best ways to optimize working capital management is by taking advantage of a well-organized and strategic early payment program based on dynamic discounting. That’s because late and delayed payments are a significant challenge for small and mid-sized businesses, with 93% of companies experiencing delayed payments from customers.
The issue is that when invoice payments are extended, delayed or outright late, you have cash tied up in receivables. That makes it harder to maintain enough cash flow to keep up with your own debts and day-to-day operational expenses. In addition to negatively impacting working capital, late payments ultimately affect long-term business growth because funds tied up in receivables cannot be reinvested back into the business.
What’s the solution?
To overcome this challenge and incentivize customers to pay their bills earlier rather than later, companies have long offered static discounts. The traditional method is to use standard payment terms with an early payment discount, such as a 2/10 net 30 trade credit, where buyers receive a 2% discount for a payment made within 10 days.
The caveat? Static discounting has become irrelevant over time as savvy businesses operating on tight margins understand the need to offset the discount by increasing prices, and buyers sometimes take advantage of the early payment rate without actually paying early. In recent years, dynamic discounting has emerged as a superior solution to help businesses bridge the gap between the supply of goods or services, and payment.
What is dynamic discounting?
Dynamic discounting entails offering a reduced payment on outstanding invoices at a discounted rate that fluctuates depending on the time frame in which the invoice is paid.
The discount is dynamic because it decreases as the invoice comes closer to the original due date. For example, if your company ships goods to a buyer and the original payment terms are 30 days, an invoice paid on day 10 would receive a higher discount than an invoice paid on day 20. If the invoice is paid at the initial due date of 30 days, the buyer would pay the full amount without a discount.
In short, dynamic discounting offers an automatic system for generating discounts without the need to negotiate with your buyers individually. Furthermore, dynamic discounting can strengthen your cash conversion cycle and bottom line, and offers value for both you and your buyers.
Here are six key benefits of using dynamic discounting to get paid early.
1. Improve your working capital
Buyers typically remit payments at the last minute so they can optimize their working capital by increasing their days payable outstanding (DPO). However, for your business to optimize working capital, you need to lower your days sales outstanding (DSO). Dynamic discounting can help to tighten up your cash conversion cycle by lowering DSO, therefore, increasing your cash on hand.
This can be a win-win situation. Your buyers that pay early can lower their costs and you free up working capital by clearing receivables faster. Moreover, using dynamic discounting can let you obtain access to capital at a cheaper cost than most other funding options, allowing your business to handle unforeseen expenditures or invest in development and creativity.
2. Gain more control over cash forecasting
Inadequate cash flow is a key reason businesses fail. A company consistently operating with a negative cash flow will run into debt sooner rather than later, and eventually shutter. Financial forecasting is the road map most companies follow to ensure they have adequate cash flow to pay stakeholders, maintain operations and effectively strategize for future growth.
An accurate cash flow forecast is vital for any business, including small and mid-sized businesses. Even when you have a surplus of cash, you could quickly be at risk of negative cash flow if one too many payments are outstanding in accounts receivable.
By accepting early payment at a reduced rate, you gain more control of when you are paid, which helps to improve the overall accuracy of your projected cash inflows. This allows you to reduce the risk of cash shortages that cause negative working capital because you are able to better predict and forecast future cash flow.
3. Achieve flexibility
As opposed to more traditional early payment discounts, dynamic discounting can be applied on an invoice-by-invoice basis. This offers you the flexibility to choose which invoices you want to accelerate payment on and when you want to participate in the program.
With dynamic discounting, buyers also have increased flexibility by being able to choose how and when to pay you, with early payments resulting in a discount on the original invoice. Essentially, with a flexible dynamic discounting solution, you benefit from choosing which invoices to discount based on your business needs — whether that means discounting a single invoice, several invoices or all invoices.
4. Leverage variable cost and timing
Dynamic discounting allows for variable cost and timing, which lets you provide a discount in real time when you need cash flow. For example, with dynamic discounting, early payment might happen four days early or 30, subject to the payment terms. In this sense, unlike static discounts, the window of time for early payment is extended throughout the entire payment term — on-demand, as needed.
With dynamic discounting, the rate of the discount can also vary. While the cost of a static discount is usually fixed upfront, depending on the model used, a dynamic approach offers variability along a sliding scale. In the marketplace model — a newer approach — both price and timing are fully dynamic, but you can initiate an offer for a discount and control the rate of discount. When you control the discount, it becomes more affordable and flexible than other options for working capital financing.
5. Save time
A big part of a streamlined and efficient accounts receivable process is getting paid on time. However, a recent Quickbooks survey showed that a majority of mid-sized businesses struggle with collecting customer payments. In fact, 65% of respondents said they spend an average of 14 hours per week on tasks related to collecting payments.
When you incentivize early payment with a dynamic discounting program, you help reduce the likelihood of nonpayment or late payments from your buyers. Getting paid faster also helps to accelerate your cash flow. Greater access to cash creates more liquidity, which impacts working capital. As your working capital increases, your business operations will become more efficient, streamlined and secure.
6. Strengthen your relationship with buyers
When you invest in building a strong relationship with your buyers, you'll both reap the rewards of your efforts. This is because a healthy supplier-buyer relationship can help to maximize supply chain efficiency, improve customer service and reduce costs, all of which ultimately boost profitability.
Buyers that pay bills early can get discounts on their payments, which can translate to a lower cost of goods sold and therefore higher profit margins. As a supplier, on the other hand, you receive payment faster, thereby improving and creating more consistent access to cash.
In essence, it is a mutually beneficial way for both buyers and suppliers to ease financial stresses and grow the business. It also helps to build loyalty, as customers may see the discount as an incentive to choose your business over your competition.
The bottom line
Ultimately, implementing a dynamic discounting program enables you to select invoices for early payment at discounts that work for your business. By offering your buyers a discount for paying your invoices early, you are building a mutually beneficial relationship.
It is an arrangement that offers significant advantages to you, as a supplier seeking to receive payment more quickly, and buyers that want to save costs when paying invoices. In addition, because the process is automated, it eliminates the risk that the buyer will take the discount while still paying at term.
Interested in how dynamic discounting can help you increase cash flow and take your business to the next level? Check out our Complete Guide to Dynamic Discounting to learn more or find out how you can get started today.