Price the discount against your own cash.
The usual answer, as in Tipalti’s guide, converts 2/10 net 30 into an annual rate of 36.7% and compares it with a bank loan. That is the right idea. It uses a 360 day year; on 365 days it is 37.2%. The number moves a lot with one input the guides leave fixed: the day you would otherwise pay.
What paying early earns
annual rate = discount / (1 - discount)
x 365 / days you pay early
2/10 net 30, paid on day 10 instead of day 30
= 0.02 / 0.98 x 365 / 20 = 37.2%
the same terms, if you usually pay on day 45
= 0.02 / 0.98 x 365 / 35 = 21.3%If your team already pays this supplier on day 45, paying on day 10 only brings the payment forward 35 days, and the discount is worth 21.3% a year. Still worth it for most companies, but it shows why each set of terms needs its own number.
Here are three example bills from one month, for a company that can borrow on a revolving facility at 8% and otherwise pays on the due date.
| Supplier | Bill | Terms | Discount | Annual rate | Interest at 8% | Decision |
|---|---|---|---|---|---|---|
| Packaging supplier | 48,000 | 2/10 net 30 | 960 | 37.2% | 206 | Take it |
| Freight forwarder | 12,500 | 1/15 net 30 | 125 | 24.6% | 41 | Take it |
| Contract manufacturer | 30,000 | 1/10 net 60 | 300 | 7.4% | 325 | Only from spare cash |
The first two pay for themselves several times over. The third does not: 1/10 net 60 works out at 7.4% a year, and borrowing 29,700 for 50 days at 8% costs 325 to save 300. Paid from cash sitting in an account earning 4%, the same early payment gives up only about 163 of interest, so it is worth taking. The answer depends on where the money comes from.
The window closes faster than the calendar says.
On standard terms the ten days run from the invoice date, not from the day finance sees the bill. Here is the packaging bill, the most valuable discount of the three.
| Date | What happens |
|---|---|
| Mon 2 November | Invoice dated. The 10 days start here. |
| Thu 5 November | Invoice reaches the AP inbox. Seven days left. |
| Thu 12 November | Approved after five working days. Last day for the discount. |
| Fri 13 November | Weekly payment run. One day late, 960 gone. |
| Wed 2 December | Due date for the full 48,000. |
Nothing went wrong here. The invoice arrived in three days, approval took a normal working week, and the payment run went out on its usual day. The discount was lost anyway. This is the ordinary way a discount gets missed, which is why the fix is in the process: route discount bills to an approver the day they land, and allow a payment outside the weekly run when a window is about to close.
Book the discount against the cost.
When the packaging bill is paid in time, accounts payable clears at the full 48,000, cash goes down by 47,040, and the 960 difference is the discount.
The payment entry
Payment of the packaging bill inside the window
Dr Cr
Accounts payable 48,000
Cash 47,040
Purchase discounts 960
------ ------
48,000 48,000
Purchase discounts reduces what the purchase cost.
For packaging held as inventory, that means the
inventory cost, not other income.Where that 960 goes is the part many charts of accounts get wrong. In November 2004 the IFRIC was asked whether discounts for prompt settlement should be deducted from the cost of inventories or recognised as financing income. It said they are deducted from the cost of inventories, under IAS 2. For a bill that is an expense, such as software or a service, the discount reduces that expense. A purchase discounts account that sits under cost of sales or the matching expense, rather than in other income, keeps gross margin honest.
One more step if the goods are still on the shelf at month end: the discount on those units belongs in the inventory balance, not in this month’s cost of sales. For most companies that is a small adjustment, but it is the one an auditor testing inventory cost will ask about.
A discount check for the payables team.
- Each set of supplier terms has an annual rate, worked out on the day you really pay, next to what your cash costs. Terms below that cost are paid on the due date.
- Discount bills are flagged when they arrive, with the days left, and go to an approver the same day.
- There is a way to pay outside the weekly run when a discount is about to expire.
- Once a month, list the bills whose discount date passed with nothing taken, and total them. That number is what the process costs.
- Discounts post to a purchase discounts account under cost of sales or the matching expense, not other income.
How Rivane handles discounts today.
In Rivane a bill can carry an early payment discount amount and the last date it can be taken. When you pay the open balance less the discount on or before that date, the payment takes the discount and posts the entry above in one step. For the packaging bill, a payment of 47,040 dated 12 November clears the 48,000 bill. The same payment dated 13 November takes no discount and leaves 960 open on the bill.
Rivane early payment discounts, as built
# Rivane early payment discounts, as built.
on the bill each bill can carry a discount amount
and the last date it can be taken
when paid a payment dated on or before that date,
for the open balance less the discount,
takes the discount; a part payment that
leaves more than the discount open
takes none
entry Dr accounts payable for the full amount,
Cr cash for what was paid, Cr the
discount account for the difference
discount posts to an income or expense account
account with "discount" in its name, or else an
other income account; with neither, the
payment is refused rather than guessed
pay run the suggested pay run lists bills with
an open discount first, proposes paying
the day before the window closes, and
shows the estimated saving; nothing is
paid until a person approves it
The limits worth knowing. The suggested pay run puts every open discount first and does not compare the rate with your cost of borrowing, so a 1/10 net 60 bill is still listed first; that call stays with you. The discount goes to the first income or expense account in your chart with “discount” in its name, so if you also keep a sales discounts account, check where the first discount payment lands. A payment cannot take a discount and withhold tax at the same time yet. There is no ready-made report of missed discounts, so the monthly list above is a filter on bills you build yourself.
The short version.
Work out each discount’s annual rate from the day you really pay and compare it with what your cash costs. Count the window from the invoice date and move discount bills to the front of approval. Book what you save against the cost of what you bought. In the example, two of three discounts were worth 1,085 a month, and the larger one was lost by a single day.
To see how Rivane takes bills from capture to approval to payment in one ledger, read the Rivane accounts payable overview.
Frequently asked questions.
Does the 10 day window start from the invoice date or the day we receive it?
Unless the supplier agrees otherwise, it runs from the invoice date. That is why the days the invoice spends in the post or an inbox count against you. Some companies negotiate terms that run from receipt of the invoice, which is worth asking for with suppliers whose invoices arrive late.
Is a purchase discount other income?
Not under IFRS for inventory. In November 2004 the IFRIC said discounts for prompt settlement are deducted from the cost of inventories rather than treated as financing income. For an expense such as software or services, the discount reduces that expense. Booking it to other income overstates both your costs and your other income by the same amount.
Should we use the gross method or the net method?
Either gives the same cash and the same cost when the discount is taken. The net method records the bill at the discounted amount, so a missed discount shows up as its own expense, which makes misses easy to see. The gross method records the full amount and needs a separate report of bills whose discount date passed with nothing taken.
Sources
- IFRS Interpretations Committee (then IFRIC), Discounts and rebates (IAS 2 Inventories), November 2004. On whether discounts for prompt settlement are deducted from the cost of inventories or recognised as financing income: they are deducted from the cost of inventories, and the requirements were judged clear enough not to need an Interpretation.
- IFRS Foundation, IAS 2 Inventories. The standard the 2004 decision applies.
- Tipalti, 2/10 Net 30 Trade Credit Terms. Read as a current answer: a 36.7% annualized rate (on a 360 day year), compared with bank borrowing, and the gross and net methods of recording the discount.
A note on how this was researched. The 2004 IFRIC decision was read directly from the IFRS Foundation’s copy. The Tipalti guide was read in full. The company, the suppliers, the 8% borrowing rate and every amount are examples. The Rivane section describes the product as built today, checked against the payables code rather than marketing copy. This is not accounting advice for your specific case.
On embedded social posts: we looked for public posts from standard setters or practitioners on early payment discounts and found none we could verify as current and relevant, so this article uses ordinary citations instead.