Cash discount – What is a cash discount?

A cash discount is an incentive offered by a seller to a buyer for paying an invoice ahead of the scheduled due date.

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Cash discounts are incentives offered by sellers that reduce the amount that the buyer owes by either a percentage of the total bill or by a fixed amount.

For example, if an invoice is due in 30 days, a seller could offer the buyer a typical cash discount of 2% if they were to pay the invoice within the first 10 days of receiving it.

Small cash discounts benefit the seller because they increase the likelihood that a buyer will pay quickly. Cash discounts therefore provide the seller with cash faster; at times, it can be better to receive 95% of an invoice within a few days for example, rather than wait 30 or more days to receive the full amount.

Being paid early means that the seller can then reinvest the cash back into the business sooner.

Cash discounts vs. trade discounts

Cash discounts aren’t reductions in the agreed sales price of the goods or services at the time of the transaction – they are a reduction in the amount to be paid by a credit customer (to whom you have given credit terms) if that customer pays within a specified time period.

A cash discount is intended to persuade credit customers to pay their bills quickly – it’s not an incentive to make the purchase.

Cash discounts: shorthand

In accounting, usually the discount amount and the time period within which it’s available, are expressed in a format such as 2/10, n/30. This means a 2% discount is applied if the invoice is paid within ten days, otherwise the payment is due in its entirety within 30 days.

Cash discounts and VAT

If, as a supplier, you offer a cash discount on condition the invoice is paid early or within a specific time frame, the VAT charged can be calculated on the basis that the discount will be taken, meaning that the VAT will be a percentage of the net amount after discount.

Here is a simple example of calculating a 10% cash discount when working with VAT:

You’ll need to work out the net price of the goods (i.e. before VAT is added):

E.g. £200.00

And then you’ll need to calculate the VAT:

Goods £200.00
10% cash discount (£20.00)
Goods after cash discount £180.00
VAT @ 20% of £180.00 = £36.00
Gross invoice total £216.00

Recording cash discounts: net vs. gross method

In accounting, there are two different ways that cash discounts can be recorded in the books: the net method and the gross method.

The net method treats sales revenue as the net amount after the given discount, and any discounts that the buyer doesn’t take are recorded as interest revenue. The discounts are essentially treated as compensation to the seller for providing credit to the buyer.

The gross method views discounts that aren’t taken by the buyer as a portion of total sales revenue – not as separate interest earnings. The gross method is the most common in business practices today.

No matter which recording method is used, a cash discount taken by a buyer will reduce sales revenue.

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