1.7 Cash Discounts
In the previous section you learned to calculate the prices businesses paid for goods. This section examines the terms of payment allowed by sellers.
After goods are sold, the vendor sends a request for payment to the purchaser. This request is usually on an invoice, a document which lists all the pertinent facts about the transaction, including the following:
- the items sold, with list prices
- the trade discounts
- conditions of delivery
- other charges (e.g., freight)
- the PAYMENT TERMS.
Payment Terms
Usually payment is not required immediately and a payment period (for example, 60 days) is given. This payment period normally begins on the date of the invoice (that is, the next day is day 1) and payment is expected by the last day of the period. The payment period allows for goods to be partly or wholly resold by the purchasing company before payment is due, and is thus an inducement to buy from the seller.
Key Takeaway
Sellers have to finance the sale during the payment period and consequently some sellers encourage payment before the end of the period by allowing a discount, called a cash discount, for early payment. The discount also helps to ensure preferential payment to the seller by companies that may be experiencing difficulties meeting all payment commitments.
The following are examples of terms:
| 2/10, n/30
|
2% discount allowed if paid within 10 days, otherwise net (full) payment due within 30 days (of the invoice date).
|
| 1/15, n/60 ROG
|
1% discount if paid within 15 days of the RECEIPT OF GOODS, otherwise net payment due 60 days from receipt of goods.
|
| 2/5, n/30, EOM
|
2% discount if paid within 5 days of the END OF THE INVOICE MONTH, otherwise full payment due 30 days from the end of the current month.
|
Key Takeaway
Example 1.7.1
Consider the following invoice:
| Ajax Wholesale Ltd.
Invoice No: 16274 Date: August 15, 2020 Ship via: Hermes Delivery
Special Instructions: Sold to: Electronicks Ltd. None |
|||
| 110 B Avenue Surrey, BC
Ship to: Same
Terms: 2/5, n/30 FOB |
PST Exemption #XXXXXXX | ||
| Quantity | Description | List Price per Unit | Amount |
|
15 |
#1472 AM-FM Radio; less 30% |
$17.50 |
$183.75 |
|
10 |
#1821 Telephone; less 30% |
12.25 |
85.75 |
|
10 |
#2171 Answering machine; less 30%, 10% |
36.00 |
226.80 |
|
Subtotal |
496.30 |
||
|
Delivery charge |
35.00 |
||
|
TOTAL PAYABLE |
$531.30 |
Note that the amounts calculated have the trade discounts deducted, but do not have the cash discounts deducted since it is not known whether or not the purchaser will pay early.
The delivery charge is listed separately and cash discounts are not usually allowed on it. This is because the delivery in this case is not the seller’s business; it is being paid on behalf of the purchaser.
If the invoice was paid in full by August 20, 2020, the payment would be:
[latex]$496.30 \times (1-0.02)+$35 =$531.37[/latex]
Otherwise the full amount would be due on September 14, 2020.
Knowledge Check 1.7
An invoice dated September 3, 2020, for six television sets with a list price of $749.00 has trade discounts of 30% and 5%. If the payment terms are 3/10, n/30, what is the payment required if the cash discount is taken?
Partial Payments
Sometimes it is not possible to pay an entire invoice at once. In this case, we can apply the discount to only part of an amount owing. This is called a partial payment.
Example 1.7.2
S&C sports receives an invoice for $4,500 for a shipment of curling shoes. The invoice is dated April 1 and has terms 3/10, 2/15, n/30.
- On April 6, S&C sent in a payment of $1000. The Curling Equipment company gives discounts for partial payments. How much does S&C owe on the invoice?
- S&C plans to send in a second and final payment on April 11. How much should this payment be?
For part (a), we need to see how much credit should be given for the $1,000 payment, given that it is eligible for a 3% discount. The discount applies to the credit given (the part of the invoice that is paid off) and not to the amount paid.
- To calculate how much to pay multiply by (1 – d)
- If given the amount paid divide by (1 – d) to get the credit
To see this, we can solve the equation:
[latex]Credit(1-0.03)=$1,000[/latex]
Dividing both sides by (1-0.03), we have:
[latex]Credit = \frac{$1,000}{1-0.03}=$1,030.93[/latex]
So, by paying the $1,000 early, S&C now owes only:
[latex]$4,500-$1,030.93= $3,469.07[/latex]
To solve (b), we multiply the amount owing by (1-0.02) to see that the final payment is:
[latex]$3,469.07 (1-0.02)= $3,399.69[/latex]
Key Takeaways
- Not all suppliers allow retailers to receive a cash discount when only part of the invoice is paid early (partial payments).
- In this text, we always assume retailers will receive a discount on the portion of the invoice that was paid early.
- You will notice that we did some intermediate rounding in the problem above. Often companies will do this type of intermediate rounding when storing amounts, but it is always important to check with the supplier, to see how they record the numbers.
Knowledge Check 1.8
In the middle of a kitchen remodel, you decide to splurge on a new refrigerator and range. The range was on back order, but you received the following invoice for the fridge:
- Invoice 1 (fridge): $2,500 dated April 4 (5/20, n/30)
On April 6, you sent in a payment of $760. Two weeks later, you receive the invoice for the range. It has the same terms as the first invoice:
- Invoice 2 (range): $3,250 dated April 19 (5/20, n/30)
- If you pay off both debts at the same time, what is the last day you can pay?
- How much will you pay?
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