Cash discount dating

The cost of capital is a mix of what debt capital would cost (e.g., a bank loan) and the cost of equity capital (selling stock).

For many small businesses the cost of capital ranges between 15 and 20 percent.

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And terms of 1/10 net 40 produce the same effective interest rate as 1/20 net 50 since the difference between the full term and the discount period is the same, 30 days.

Before going further, note that we used 360 as the number of days in the year.

Cash discounts are not reductions in the set sales price of a good or service at the time of the transaction – they are a reduction in the amount to be paid by a credit customer (one that is not paying in cash) if that customer pays their debt within a specified time period.

Cash discounts are offered in order to persuade credit customers to pay their bills faster – they are not meant as an incentive to make the purchase in the first place.

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The gross method is most commonly used method in business practice today.

In the net method however, sales revenue is treated as the net amount after the given discount, and any discounts that the buyer doesn’t take are recorded as interest revenue.

Cash discounts are incentives offered to buyers that reduce the amount owed to the seller by either a fixed amount or a percentage of the total bill.

If an invoice fx is due in 30 days, a seller could offer the buyer a cash discount of say 2% if the invoice is paid within the first 10 days of receipt.

There are times to take the discount and times to offer one and times to say no on both sides. First, you've got to compare taking or giving the discount to your cost of capital.

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