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Dynamic Discounting | What You Need To Know
Cash flow is a major concern for businesses, no matter their size. Getting invoices paid early can be a huge help, especially in more complex supply chains where a delay in the middle has a knock-on effect throughout.
Invoicing financing, purchase order financing, and other forms of trade finance can all help businesses by providing the funding needed to help bridge the gap to smooth both product supply and service contracts.
Discounting provides a way to encourage the early payment of an invoice - but what does it entail, and what is dynamic discounting? At Clifton Private Finance, we have the answers.
And to get a quote on invoice financing options your business is eligible for, use our free comparison tool below:
Traditional Discounting - Or, You Scratch My Back, and I’ll Scratch Yours
Offering a discount on your invoice for early payment is a basic concept. Not to be confused with the industry term invoice discounting, which refers to a specific type of invoice finance product, traditional discounting is as simple as it comes and has been around since the dawn of invoicing.
Discounting can come from the buyer or be requested by the supplier, and works as follows:
- Buyer obtains goods or services from the supplier, on standard invoice terms (30 days net, for example).
- Supplier issues an invoice.
- Buyer has 30 days to pay the invoice. They have the money to hand and can afford to pay right now, but it’s earning interest and being used as liquid capital, so there’s no incentive to spend it early.
- Buyer is aware that supplier would like the money sooner.
- Buyer contacts supplier: ‘Hi, would you be interested in offering us a discount of 2% if we pay your invoice early?’
- Supplier considers the offer. With a need for immediate cash, they’re happy to accept.
- Buyer pays the invoice immediately, saving 2% of the total.
- Both buyer and supplier gain.
Of course, it could have been that the supplier goes to the buyer with the offer. ‘Hi, if you pay within the first five days, we’re happy to give you a discount of 2%’.
For many businesses, traditional discounting provides a method whereby capital in the hands of the buyer can be leveraged to save money and improve the cash flow of the supplier.
The Weight of Discounting
The problem with traditional discounting is the administrative load associated with the flexibility.
It’s possible to avoid some of the administrative effort by simply offering a standard discount (2% if paid within 10 days, for example) on every invoice, but what if the supplier doesn’t want to do that when their cash flow improves?
Are they obliged to continue with the arrangement? And what if the buyer is looking to pay after 20 days - can they get any discount at all? Is the supplier willing to do a 1% discount at that time?
Administrative overheads and inflexibility grow.
Dynamic Discounting - Discounting With Technology
Dynamic discounting works by integrating your business systems with the dynamic discounting platform, providing a seamless automated process that facilitates flexible discounting.
How ERP Facilitates Dynamic Discounting
Business ERP (Enterprise Resource Planning) systems help manage the disparate parts of business administration, such as finance, stock, human resources, and customer relationship management.
With dynamic discounting and ERP, businesses with the capital available to take advantage of discounting opportunities can present their suppliers with a non-obligatory option for discounting on every invoice. It’s easy to use and very effective.
Upon receiving an invoice, the system contacts the supplier and invites them to consider a discount.
An Example of Dynamic Discounting Flexibility
As an example, consider a supplier who has issued an invoice for £100,000 to a buyer who uses dynamic discounting. They receive an email generated from the system that invites them to log on and view their dynamic discounting options.
They are presented with a flexible choice: leave the invoice as it is and get full payment at 30 days, or choose to be paid early by providing an appropriate discount. This could be 2% if paid within ten days, similar to traditional discounting, but is adjustable:
- 1.5% if paid on day 15
- 1.2% if paid on day 18
- 1% if paid on day 20
- and so on…
Automatic dynamic discounting like this remains open for as long as needed. Perhaps the supplier doesn’t need the money immediately and is happy to wait the full term, and simply leaves the dynamic discounting untouched, but then, ten days later, runs into a cash flow problem and is looking for additional funds.
Rather than turn to traditional business financing, they can log back into the dynamic discounting system, accept the terms for that day, and allow the invoice to be processed.
With the buyer’s dynamic discounting tied directly to their ERP, the agreement of the discount is made, the payment is agreed, and the accounting system automatically schedules payment for that day.
Dynamic Discounting for Smaller Businesses
Dynamic discounting is best suited for larger businesses. With a reasonably in-depth set up, and requirement for system-wide ERP integration, smaller businesses might struggle to justify the cost of the resources required to make dynamic discounting part of their business model.
However, that doesn’t mean dynamic discounting is out of reach.
Small suppliers often struggle more with cash flow during long invoice terms than larger companies, so it is always worth discussing discounting with buyers.
Working with buyers to build an understanding improves long-term relationships - discounting can help.
The Benefits of Dynamic Discounting
Dynamic discounting shows the advantages of businesses being willing to consider each other and work collaboratively for the benefit of all, including:
For the Buyer
- Saving on products and services
- Boosting relationships with suppliers
- Utilising existing capital for strong return
- Managing cash flow
- Increasing buying power
For the Supplier
- Help bridging long invoice terms
- Cash flow support
- Access to funds earlier to fuel business expansion
- Improving customer relationships
- Increasing brand loyalty
4 Alternatives to Dynamic Discounting
Dynamic discounting is not the only way to combat the difficulties of cash flow during long invoice terms.
Other options include:
Invoice Discounting
Though the term is somewhat confusing, similar as it is to traditional discounting and dynamic discounting, invoice discounting is a finance product where banks or other lenders provide short-term loans or revolving credit facilities that leverage unpaid invoices (accounts receivable) as collateral.
Invoice Factoring
Invoice factoring involves selling unpaid invoices (accounts receivables) to a third party ‘factor’ who then directly collects the money, providing businesses with a way of obtaining funds for invoices before payment terms are due.
Reverse Factoring / Supply Chain Finance
Reverse factoring is when the buyer applies for finance to pay a supplier early, often taking advantage of traditional discounting. Some dynamic discounting service providers offer reverse factoring as an additional package for businesses looking to combine dynamic discounting with third-party finance.
Purchase Order (PO) Finance
Applied for in the early stages by suppliers looking to fulfil an order, PO finance provides funding for a trade contract for capital and cash flow. While it comes at a different stage in the process to dynamic discounting, it serves a similar process in providing funds leveraging future payments.
Apply for Cash Flow Advice and Finance
Is your business looking for support to shorten the gap between an invoice being issued and paid?
Speak to a business finance expert at Clifton Private Finance for advice and access to the wide UK marketplace of specialist cash flow finance solutions.
Contact us today to learn more about dynamic discounting and invoice finance.
