Cash Discounts – Cash is King. In the current
business climate investors are moving away from fundamentals in
evaluating a stock to a very detailed look at a firm’s balance sheet.
One of the reasons for this paradigm shift is some companies are taking
advantage of the allowance for bad debt to artificially inflate the
company’s earnings. In doing so, the company’s fundamentals will
continue to look strong when in actuality they have underestimated the
amount of bad debt they are carrying in accounts receivable. Some
businesses attempt to reduce the exposure to uncollectable debt by
reducing the use of accounts receivable in general but there are cases
when this is impossible. A predominate way of keeping accounts receivable
to a manageable size is to offer cash discounts which benefit both the
seller and buyer of a good or service. A cash discount is a fixed
percentage off of the cost of a good or service for prompt payment. For
example if a painter provides a quote to paint a house for $1,000 but if
the owner pays in cash at the time of service the painter will only
charge $950. On the surface this situation gives the impression that the
customer received a benefit from the cash discount in the amount of 5% of
the quoted price but the painter received no such benefit. In fact the
impression could be given that the cash discount was detrimental to the
painter because the overall fee was reduced by $50. Digging deeper into
the painters thought process benefits of the cash discount will become
apparent. Firstly by receiving the payment in cash the painter does not
have to worry about fees for a credit card transaction (2%-4%).
Additionally the painter is then protected from charge backs and
fraudulent credit cards due to identity theft. If the homeowner chose to
finance the cost of the service then the painter would be exposed to the
possibility of the homeowner not paying the debt. If this happens the
painter would have to expend time in attempting to collect that debt or
sell the debt to a collection agency at a loss. If the painter is paid
cash at the time of transaction both of these scenarios are mitigated;
there is no credit card fees to pay and there is no threat of a non
paying customer. Offering cash discounts is especially beneficial
to small businesses because discounting the price of a good or service is
outweighed by the overhead needed to collect on bad debts. A small
business can still offer an accounts receivable function with a minimal
staff to maintain it if a significant cash discount is offered. In larger
organizations a full accounts receivable and collections staff is able to
handle a sizable credit function, but by minimizing the risk of bad debt
by offering cash discounts the company can focus on its core business
while maintaining a lean accounts receivable staff. Cash discounts
are a great way to save money for the consumer as well as provide peace
of mind to the seller. When the buyer has cash on hand to pay for a good
or service quickly and the seller discounts the price for the prompt
payment both parties win.