When selling to customers, there are different types of discounts that can be offered. But before offering a discount, companies need to take careful consideration of the impact the discount could have on profit margins.
Why offer discounts?
When you sell to customers on credit, you are taking a risk by allowing them to take the goods now, and pay later, and you will need to give terms for when you expect payment to be received.
This can have a negative effect on cashflow, as it means you are waiting for money to be received, while still paying out other costs in the meantime. To avoid this problem, and encourage customers to pay on time, some businesses offer a discount, in this case known as a settlement discount.
When encouraging customers to make a purchase, offering a discount can be very persuasive, and increasing sales in this way can help to grow the turnover of the business. These discounts can be bulk discounts (discounts for buying multiple products) or trade discounts (discounts for a particular trade).
When offering any kind of discount, the company needs to think about profit margins as, while it may encourage a sale, it may mean the product is no longer profitable.
The trade discount is normally a percentage discount that is calculated off the total amount of the goods. For example, the value of the sale might be £1,000. You may offer a 5% discount because the customer is in a particular trade. This means the new net amount of the invoice is £950, as the discount is £50. On the invoice, you will want to show that the discount has been given, so that the customer is aware they have got the goods for a lower price.
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The bulk discount is normally a percentage discount that is calculated off the total amount of the goods. For example, the value of the sale might be £900. You may offer a discount of 10% because the value of the invoice is over a certain amount, or because a particular number of items have been purchased.
The net value is now £810, as the discount is £90. Again, you will want to reflect the discount on the invoice.
The settlement discount is normally a percentage of the total invoice. The discount is then only taken if the customer pays within a certain amount of time. For example, an invoice may normally be paid within 30 days, but if you pay within 14 days then the invoice is discounted by 2%, encouraging early payment.
While this discount is a cost to the business, it is often outweighed by the improved cash flow caused by early payment.
Too many discounts
Some companies will set a policy where only one of the discounts can be offered on anyone sale. This is so that the business does not sell the product at a loss.
Discounts are covered in more depth on our AAT courses.