One of the best returns on your investment that you can get in your business is taking advantage of payment discounts that your suppliers offer. Now, maybe only a handful offers it, but when it comes it has a very high ROI and should be something to take advantage of.

For example, suppose the terms are 1% 10, net 30. That would mean you’re paying 20 days sooner and saving 1%. Based upon a 360 day year to keep the math simple, this represents an annual return of 18%. That’s certainly much higher than you could get on a savings account with your bank.

If the terms are 2% 10, net 30. You can see that it’s even better 36%. That should even be higher than the return on equity in most companies. So the first step is to do the calculation and determine what the return on investment is. To do that, you look at the difference between how many days you’d have to pay in to take the discount versus how many days you’d have to pay without the discount. In the above example, it was 20 days or 30 minus 10. Then you’d take 360 days in the year and divide that by the number of days in the discount period. In the above example, it was 360 days divided by 20 or 18. The final step then is to multiply that number of periods times the rate per period. In the above examples, it was either 1% or 2%, leading to returns of 18% or 36%.

Then you compare it against what is your cost of money. Normally, your cost would be your cost of bank debt and your cost of equity. You would take the weighted average of the two. In almost all cases, the return from the payment discount is going to be greater than your average cost of capital. So, it makes sense to take advantage of the payment discount.

Suppose a supplier has not offered such a payment discount. Go ahead and ask them. It could be you’re just getting the standard terms, but they do have alternate terms available. Perhaps, you can work something out.

What I don’t recommend is what some companies will do. That is to take the payment discount, but still pay on the regular payment due date. In other words, this would be taking off 1% or 2% from the payment, while still paying in 30 days. I don’t think that’s a good practice and sets up an adversarial relationship with a lack of trust. What if your cash flow is a little bit short to be able to take advantage of the payment discounts? Perhaps, see what you can do line up some more capital. I mean, it could be a worthwhile return to borrow some on your line of credit in order to take advantage of the payment discounts because you get a higher return. You might find the situation’s just temporary and that as your cash flow builds up over time, you won’t have to dip into the line to make it happen.

So when you have a chance when a supplier offers you a payment discount, jump on it. It can be one of the best returns of money you’ll ever get.

Jon Paul, MBA, CPA, CMC, CM&AA

President, Value Added Finance Resources
Bringing new insights on results and maximizing company value