One of the most common problems experienced by businesses is late payments. Clients not paying their invoices promptly can cause problems with cashflow, potentially damaging the company. There are a number of ways to reduce the number of debtor days, and offering a discount as an incentive for early or prompt payments is just one of them.
What is an early settlement discount?
An early settlement discount isn’t an appropriate solution for all types of business. If you issue invoices and offer credit terms, this solution is probably right for your company. The level of discount can differ for various customers. You may want to consider different levels of discount for early payment and for payment within a specified period.
How is VAT affected by early settlement discount?
If your company has a turnover below the threshold for VAT, you won’t have to worry about calculating VAT. However, if your turnover exceeds the threshold, you will have to take it into account.
Until 1st April 2015, the amount of VAT at 20% would be calculated on the discounted amount payable, whether the customer took advantage of the discount or not. After this date, however, VAT is to be calculated on the amount the customer has paid. If you outsource to a finance and accounting service, this may not affect your business, but a small business that deals with the bookkeeping themselves may notice an increase in administration from April 2015.
If a company currently offers a discount for early settlement, there could be initial one off costs to implement changes to the system. You may want to seek professional advice so that you can decide whether discounts will still be beneficial once you have taken implementation costs into account.
Benefits of offering early settlement discounted
Depending on costs of implementation, there are many benefits of offering discounts for early payment. One of the most significant of them is receiving payment either early or on time. A business depends on prompt payment for a healthy cashflow. If customers don’t settle their debts promptly, the supplier may not be able to pay employees or his own suppliers, which could result in the business failing.
As the number of debtor days increases, the risk of not being paid also increases, which ultimately causes problems for the supplier.
If you are paid on time by clients, you will have an improved chance of maintaining a healthy cashflow, which reduces the likelihood of having to borrow from other sources to cover the shortfall.
If you would like to know how early payment discount could improve your cashflow, why not use our cashflow improvement calculator?