Perhaps you’ve noticed competitors offering discounts for early payment and are tempted to do the same? Offering discounts for early payment can indeed be useful, but it’s not a great strategy to become overly reliant on. Let’s break down the pros and cons to help you decide if and when discounting for early payment is the right strategy for your construction business.
Pros and Cons of Early Payment Discounts
At Levelset, Tom Scalisi underscores that speedy payment has a lot to do with success in construction, and observes, “Payment incentives are critical when it comes to collecting faster payments and growing your construction business.” Indeed, carefully offering discounts for early payment can mean having more money on hand to cover expenses, invest in growth or handle emergencies. Three additional pros of offering discounts for early payment include:
- Reduced Risk of Late Payments: Clients are motivated to pay promptly to snag the discount, decreasing the likelihood of chasing down overdue invoices.
- Stronger Client Relationships: It can be seen as a gesture of goodwill, showing you value their business and are willing to offer a perk for prompt payment.
- Competitive Advantage: In a competitive market, offering this incentive can make your business more attractive to potential clients.
On the other hand, keep in mind that discounts for early payment ultimately mean your business will earn less on each project. To understand how much less, you need to carefully calculate the discount. Though even modest discounts for early payment can be helpful with cash flow, as the U.S. Chamber of Commerce illustrates via a BDC Bank analysis, over reliance on this tactic for the long haul can really cut into profits:
BDC Bank offers some simple, back-of-envelope calculations to help assess whether an early payment discount is financially savvy. In their calculation, your business offers a 2% discount for customers that pay an invoice in 10 days. Otherwise, the full amount is due in 30 days (2% 10 net 30). Essentially, your business is gaining the use of money for 20 days in exchange for 2% off. A 2% return over 20 days is a 37% return when annualized. Your own return on investment or financing cost would have to be above 37% for it to make sense to offer a 2% 10 net 30% discount on an invoice. It would have to be above 18% for it to make sense to offer a 1% 10 net 30% discount… .Unless your business is experiencing cash flow issues…offering this early payment discount probably isn’t worth it.
In addition to the ultimate impact early discounts can have on profits, other cons to this tactic include creating administrative complications and potentially adding to your overhead, as you track discounts and adjust invoices. Then too, some clients might try to take advantage, or habitually wait for the discount before paying, even if they have the funds readily available. If you do opt to experiment with discounts for early payment, consider which type will best help you. Typical types of discounts include:
- Percentage-based discount: Offer a 2% discount if the invoice is paid within 10 days of the invoice date (e.g., “2/10, Net 30”).
- Fixed amount discount: Offer a flat $100 discount for payments received within a week.
- Early payment periods: Experiment with different timeframes, like 7 days, 15 days, or even offering a larger discount for payments made within 2 days.
- Tiered discounts: Offer increasing discounts for progressively faster payments (e.g., 1% for 10 days, 2% for 5 days).
Keep in mind that the successful use of discounts as a carrot for early payment requires extra care with customer communication, and in monitoring the impact of your strategy on your business. For example, be sure to:
- Clearly communicate the discount terms on your invoices and in your contracts.
- Factor the discount into your pricing to ensure you maintain profitability.
- Monitor your cash flow to see if the discount is having the desired effect.
- Be prepared to adjust the discount or discontinue it if it’s not working for your business.
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