Discounts in contracts
Offering discounts to customers is normally justified when it results in higher overall profits. Even when a company has a shortage of cash, discounts can be granted in order to increase sales and cash inflows.
Discounts can be offered to encourage different types of customer behaviour
- Encourage early payment of invoices
- Encourage the purchase of higher volumes of goods
- Promote the signing of a long-term contract
- Promote a long-standing business relationship and acknowledge the value of the customer
- Acknowledge a customer's superior creditworthiness
- Acknowledge a customer's acceptance of lower or inconsistent quality products
All other things being equal, discounts for early payment are preferable to penalties for late payment
- Higher revenues result in higher taxes, discounts lead to lower taxes.
- As a practical matter, incentives generally work better than penalties.
Analysis of discounts
Discounts encourage early payment, but at a cost
Early payment by customers frees up cash that can then be invested or otherwise used in the business instead of being tied up in inventory or receivables
Thus, customers should be offered a discount to encourage early payment
However, the cost of the discount should not exceed the benefits from early payment
A discount scale can be developed which relates payment periods to discounts
challenge to win