Cash Discounts

The last element in the credit policy decision, the use of cash discounts for early payment, is analyzed by balancing the costs and benefits of different cash discounts. For example, a firm might decide to change its credit terms from “net 30”, which means that customers must pay within 30 days to “2/10. net 30”, where a 2 percent discount is given if payment is made in ten days. This change should produce two benefits: (1) It should attract new customers who consider the discount to be a price reduction and (2) the discount should cause a reduction in the days sales outstanding, because some existing customers will pay more promptly in order to get the discount. Offsetting these benefits is the dollar cost of the discounts. The optimal discount percentage is establish at the point where the marginal costs and benefits are exactly offsetting.

If sales are seasonal, a firm may use seasonal dating on discounts. For example Slimware Inc. a swimsuit manufacturer, sells on terms of 2/10, net 30, May I dating. This means that the effective invoice date is May I, even if the sale was made back in January. The discount may be taken up to May 10; otherwise the full amount must be paid on May 30. Slimware produces throughout the year, but retail sales of bathing suits are concentrated in the spring and early summer. By offering seasonal dating, the company induces induces some of its customers to stock up early, saving Slimware some storage costs and also nailing down sales.