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What is an early payment discount?

An early payment discount is offered by some companies to motivate credit customers to pay sooner. For instance, a company that sells on credit may offer credit terms such as 1/10, net 30. This means that a customer is allowed to deduct 1% of the amount owed on an invoice if payment is made within 10 days instead of paying the full amount in 30 days. In other words, the customer saves 1% of the amount owed by paying 20 days early. To illustrate the early payment discount, a $1,000 obligation with terms of 1/10, net 30 will mean that the $1,000 obligation will be settled in full for $990 if paid within 10 days.

If the customer has adequate cash or a readily available line of credit, the 1% early payment discount for paying 20 days early equates to a very attractive annual return of approximately 18%. If the customer does not have cash or a credit line available, the early payment discount may be small compared to a bank overdraft fee.

The early payment discount is also referred to as a prompt payment discount or cash discount. The seller often refers to the early payment discount as a sales discount, while the buyer may refer to the early payment discount as a purchases discount.