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Dynamic Payables Discounting: How is it Different from Traditional Discounts?

Everyone likes a discount.  According to a 2014 Protiviti study1, working capital management is one of the top five priorities for CFOs and financial professionals.  One way a business can improve its capital management is by capturing early payment discounts. While organizations may have successfully negotiated early payment discounts (like 2% 10 net 30), they are not always in a position to capture available discounts.

A report released by PayStream Advisors in 20142 found that many companies are unable to capture all of the payables discounts available to them due to a decentralized intake system of invoices, a high incidence of exceptions and manual routing of invoices – all of which contribute to a delayed approval and payment process.

So what can companies do to help solve these issues and reduce costs?

One way is to use front-end automation to receive invoices electronically and have them automatically routed for approval.  This solution can go a long way in helping to accelerate the invoice process and payment life cycle.  Companies with automated processes for payables will likely be in a better position to approve their invoices within a 10-day discount window and capture early payment discounts offered by suppliers.  In the long term, capturing these discounts can help lead to better cash flow management and a more robust bottom line for a business.

But what about those companies that take longer than 10 days to process invoices?  For example, why should their discount opportunity go from 2 percent on day 10 to 0 percent on day 11?  This is where the concept of dynamic discounting comes into play.

Dynamic discounts are calculated differently than traditional discounts.  The traditional early payment discount model usually works on the assumption that a buyer organization can capture as much as a 2 percent discount by paying an invoice within 10 days of the invoice date.  The discount can drop to 0 percent from day 11 to the due date of the invoice.

Comparing early payment discounts and dynamic discounts

Discount graph

Dynamic discounting extends the discount period by calculating the discount on a sliding scale from day 1 to the due date on the invoice.  An organization can still hope to achieve a discount of 1.2 percent if a payment is made on day 15 (see the chart above).  The funding for the payment typically comes from the buyer’s working capital, but in some cases it could be funded using third-party capital.

Dynamic discounting solutions help:

  • Provide buying organizations with the ability to capture discounts as working capital needs dictate, rather than having to negotiate discounts in advance.
  • Allow suppliers to control whether or not a discount is offered on a specific invoice, in exchange for early payment.
  • Calculate discount rate and payment amount depending on how many days are remaining until the due date.

Dynamic discounts can take two forms:

  • Recurring Discounts: In this scenario, every invoice from a specific supplier is paid as soon as it is approved and the discount depends on the payment date and the discount rate that was previously negotiated with the supplier.
  • One-Off Discounts: In this case, all approved invoices are presented to suppliers for a discount.  Suppliers then have the option to discount a specific invoice or a set of invoices based on the discount terms offered by the buyer.

Below is a chart that shows the potential benefits of dynamic discounts for both buyers and suppliers:

 

Buyer Side: Supplier Side:
Buying organizations can realize tangible savings from the incremental discounts they can now capture Suppliers can choose whether or not to offer a discount on an invoice-by-invoice basis, depending on their immediate need for cash
Choose whether or not to take a discount on specific invoices, depending on their cash flow positions Opportunity to reduce their days sales outstanding (DSO) if they offer discounts in exchange for early payment
Offer a viable and typically cheaper financing alternative to purchasing cards to their supplier base Access to a cheaper financing alternative compared to more expensive options like factoring or asset-based lending
Ability to help improve their cash management as well as supplier relations Ability to improve their cash flow as well as customer relations

These multiple benefits show that dynamic discounting can be a win-win solution for all involved.

 

Learn More About Electronic Invoicing Solutions from ADP

 

1 2014 Finance Priorities Survey, Protiviti, Inc.

2 AP and Working Capital: Increasing Revenues from Early Payments



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