The relationship between a seller and a customer has always been a muse for those who closely follow market trends and the business world. The seller often tries to lure the customer by giving several incentives, offers or discounts. The seller uses a cash discount to motivate the buyer to pay the invoice within the specified period. Apart from this, businesses also practice trade discounts. But in this article, we shall try to understand the concept of cash discount and how to calculate it with examples.
Did you know?
A cash discount is a scheme that is not legally included in a contract, and it is just a tool to motivate the buyer or customer to make payments faster.
Also Read: What is Inventory Valuation, and Why is it Important?
What is Cash Discount in Accounting?
Cash discounts, also called ‘early payment discounts’ or ‘prompt payment discounts’, refer to an inducement offered by a seller of goods or service providers to a buyer to motivate him to pay a bill before the scheduled due date. The seller reduces the unpaid amount by a certain percentage, thus offering a price reduction called cash discounts.
Various Terms Related to Cash Discounts
To better understand the concept of cash discounts, knowledge about a few terms is important:
1. Duration of Cash Discount
This is the period given to a buyer or customer to pay the due amount and get the discount before the scheduled due date.
2. Sum of Cash Discount
The net due amount is to be paid by the buyer after applying that certain percentage of price reduction offered by the seller.
3. Percentage Discount
The percentage of the sum subtracted from the total amount supposed to be initially paid by the buyer or customer.
Cash Discounts: Methods and Examples
There are various methods for calculating cash discounts:
-
Ordinary Dating Method
When the credit term reads [4/20, n/30], the buyer gets a discount of 4% on the amount to be paid if he makes the payment within 20 days. Also, the buyer should clear the bill within 30 days to escape any interest charges.
For example,
A buyer received a bill of ₹6,000 dated 13th October 2020 with terms [ 4/20, n/30]. He paid the entire sum on 31st October 2020. The effective amount then paid by the buyer would be
The date of Invoice: 13th October 2020.
First day of the cash discount duration: 14th October 2020.
Last day of the cash discount period: 31st October 2020.
Date of payment: 30th October 2020.
Cash discount = Price x Discount rate
= ₹6,000 * 4/10
= ₹240
Amount effectively paid by the buyer = Bill value (- ) Cash discount
= ₹6,000 - ₹240
= ₹5,760
-
End of the Month Method [E.O.M]
When the credit term reads [4/20, n/30 E.O.M], it means the buyer gets a discount of 4% on the amount to be paid if he makes the payment within 20 days of the following month from the date of the bill. Also, the buyer should clear the bill within 30 days of the next month to escape any interest charges.
For example,
A buyer received a bill of ₹6,000 dated 05th April 2021 with terms [ 4/20 E.O.M]. He paid the entire sum on 10th May 2021. The effective amount then paid by the buyer would be:
Date of Invoice: 05th April 2021.
First day of the cash discount duration: 1st May 2021.
The last day of the cash discount period: is 10th May 2021.
Date of payment: 10th May 2021.
Cash discount = Price x Discount
= ₹6,000 * 4/100
= ₹240
Amount effectively paid by the buyer = Bill value (- ) Cash discount
= ₹6,000 - ₹240
= ₹5,760
-
Receipt of Goods Dating Method [R.O.M]
When the credit term reads [4/20 R.O.M], it means the buyer gets a discount of 4% on the amount to be paid if he makes the payment within 20 days after receiving the goods.
For example,
A buyer received a bill of ₹6,000 dated 10th June 2019 with terms [ 4/20, n/30 R.O.M] for goods that arrived on 5th July 2019. He paid the entire sum on 10th July 2021. The effective amount then paid by the buyer would be
Date of Invoice: 10th June 2019.
First day of the cash discount duration: 6th July 2019.
Last day of the cash discount period: 14th July 2019.
Date of payment: 10th July 2021.
Cash discount = Price x Discount rate
= ₹6,000 * 4/100
= ₹240
Amount effectively paid by the buyer = Bill value (- ) Cash discount
= ₹6,000 - ₹240
= ₹5,760
Also Read: An Introduction to Accounting - Basic Features of Accounting
Cash Discounts: Advantages and Disadvantages
The following are the advantages and disadvantages of cash discounts:
|
Advantages of Cash Discount |
Disadvantages of Cash Discount |
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2. The cash discount policy would increase monotonous accounts keeping for recording the discounts made on payments. |
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3. Increase in the amount of time invested and complex assessments to calculate cash discounts on bills. |
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4. Cash discounts can also, at times, lead to a reduction in the value of sales or the turnover of the business. |
Conclusion
A cash discount is an incentivising tool used by the seller to attract the customer into paying bills within or before the stipulated time leading to increased profits for both seller and the customer. Hence, it becomes important to understand the concept of cash discount prevalent in the market and business world. The article explains the meaning, method and examples of cash discount and discusses the required terms.
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