Early payment discounts (2/10 Net 30): when they are worth it

The format is always discount / discount days, then the full term:

The days are usually counted from the invoice date, the same way as the main term. Our guide to Net 30 payment terms covers how to count them and how to set terms so they hold.

A discount on longer terms like 2/10 Net 60 is one way to get something back when a large customer insists on a long wait. Our guide to Net 60 payment terms covers the other options.

You will also see these called cash discounts or prompt payment discounts. In the UK, "settlement discount" and "prompt payment discount" are the more common names.

Say an agency invoices $12,000 on 2/10 Net 30, dated March 1. If the customer pays by March 11, they pay $11,760 and the agency gives up $240. If they pay on March 31, they pay $12,000.

Two percent sounds small. It is not, once you look at what it buys.

The annualized cost

On 2/10 Net 30, the customer gives up nothing by waiting until day 10, so the discount only buys you the days between 10 and 30: 20 days. You are paying 2% of the invoice to have the other 98% twenty days sooner.

A common way to compare that with other costs of money is to annualize it:

Annualized cost = [Discount %] / (100 - [Discount %]) x 365 / ([Full term days] - [Discount days])

2/10 Net 30:  2 / 98 x 365 / 20  = about 37% a year
1/10 Net 30:  1 / 99 x 365 / 20  = about 18% a year
2/10 Net 60:  2 / 98 x 365 / 50  = about 15% a year

Seen from the buyer's side, that is a very good return, which is why a customer with spare cash will often take the discount. From the seller's side, it is the same number the other way round: you are paying roughly 37% a year for that money. Compare it with what any other way of bringing cash forward would cost your business.

The cost against your profit

The second test is margin. A discount comes straight out of profit.

Say a consultancy makes a 15% profit margin on a $12,000 project. The profit is $1,800. A 2% discount is $240, which is about 13% of that profit. On a 40% margin job, the same $240 is 5% of a $4,800 profit. The higher your margin, the easier a discount is to absorb.

When customers already pay late

The sums change if customers usually pay well after the due date. Say the same $12,000 invoice is normally paid on day 45. A discount taken on day 10 brings payment forward 35 days, not 20, and the annualized cost falls to roughly 21%.

That can make a discount look like a fix for slow payers. Before you rely on it, check why they are slow. Your accounts receivable aging report shows who pays late and by how much.

It tends to make sense when most of these are true:

• Cash timing is the real problem. You have payroll, subcontractors or materials to pay before customers pay you, and 20 days sooner makes a real difference.
• Your margin can carry it. You have priced the work knowing some customers will take the discount.
• The customer can actually pay in 10 days. Smaller customers with an owner who approves payments can. Customers with a fixed monthly payment run often cannot, whatever the incentive.
• You can apply it consistently. You will put the deadline on every invoice and hold to it.
• It replaces something more expensive. If the alternative is borrowing to cover a cash gap, a discount may be the cheaper option. Work out both.

Skip it, or try something else first, when:

• Customers are late because of process. A missing PO, a wrong contact or an unanswered query will hold an invoice up whether there is a discount or not. Fix the blocker instead.
• Margins are thin. A 2% discount on a low-margin job can turn a decent project into a poor one.
• Customers already pay on time. You would be paying for something you already get.
• You will not police the deadline. A discount that customers take on day 25 is just a price cut.

Most service businesses get more from these than from a discount:

• Deposits and staged billing. Ask for part of the fee up front, or invoice at milestones, so no single unpaid amount gets large.
• Shorter terms on new or slow customers. Net 15, or payment on receipt, for customers with no history or a poor one.
• Clear invoices sent on time. Due date, PO number, the right contact and how to pay, sent the day the work is done.
• A reminder before the due date and a follow-up the day after. Our payment reminder email templates cover both.
• Late payment terms, where agreed and lawful. The stick instead of the carrot. Rules differ by country: see our guides to late fees on invoices in the US and late payment interest in the UK.

Put the terms in your quote or contract first, then repeat them on every invoice with the dates and amounts worked out. The customer's team should not have to calculate anything. Our guide to invoice terms and conditions covers what else belongs in that block.

Wording for a quote or contract:

Payment terms: 2/10 Net 30. A [2]% discount applies if payment in
full is received within [10] days of the invoice date. Otherwise
the full amount is due within [30] days of the invoice date.

The discount applies only to payments received by the discount date.
Payments received after that date must be for the full invoice amount.

Wording for the invoice itself:

Invoice total: [Amount]
Pay [Discounted amount] if received by [Discount date]
Otherwise pay [Amount] by [Due date]

Showing both amounts and both dates stops most disputes before they start.

This is the most common problem with early payment discounts. The invoice was due at full value, but the customer paid on day 24 and deducted 2% anyway.

Decide your rule before it happens. Some businesses let a day or two of lateness go. Others always ask for the balance. Either is fine. Being inconsistent is not, because customers learn quickly which suppliers will let it slide.

If you ask for the difference, keep it factual and short:

Subject: Balance of [Discount amount] on invoice [Invoice number]

Hi [First name],

Thank you for your payment of [Amount paid] on [Payment date] for
invoice [Invoice number].

The early payment discount on this invoice applied to payments
received by [Discount date]. As payment arrived after that date,
the full amount of [Invoice total] was due, leaving a balance of
[Discount amount].

Could you let me know when the balance will be paid? I've attached
an updated [statement / invoice] showing it.

Thanks,
[Your name]

If the customer says the payment was sent on time, ask for the remittance details and check them against your bank before going further. A short statement of account makes the open balance clear to both sides. If they disagree with the terms themselves, treat it as an invoice dispute and settle what was agreed before chasing further.