Discounts: Can you sue them to boost cash flow?

Discounts are a popular marketing tool to encourage clients and customers to pay faster. Many suppliers offer them to improve their cash flow. Like many professionals, some veterinarians offer a trade discount of sorts for immediate payment upon completion of services, but they may give little thought either to the cost of offering discounts or how much they might save by using discounts offered to them.

Table 1

Prompt client payments improve a practice's cash flow, reduce the need for borrowing working capital and result in far fewer collection problems. Little wonder, then, that many professionals and businesses offer discounts or other incentives to speed payments.

But how much can your practice profit from discounts your suppliers may offer?

Many veterinarians follow the old adage: Always delay cash outflows. That means paying bills on time but never before they are due. In reality, however, most practices would be better off paying certain bills early to take advantage of trade discounts. Consider the math:

The supplier's invoice includes credit terms, usually based on the period for which credit is extended, the size of the discount offered if the buyer pays cash and the date the credit period begins.

A cash discount is a reduction in the purchase price if the buyer pays within a certain period. Such terms typically may be stated as "2/10 net 30." The buyer knows that means a 2 percent discount will be given if the invoice is paid within 10 days. Otherwise, the balance is due in 30 days.

Why should anyone pay quickly in order to take advantage of a mere 2 percent discount?

Assume that a practice is offered those terms on a $1,000 janitorial-supplies purchase. By taking the discount, the practice will pay $980. By ignoring it, the practice pays $1,000 within a month.

Deciding against the discount means the buyer is paying $20 to keep the money for an extra 20 days. Because there are slightly more than 18 20-day periods in a year, the interest cost, on an annual basis, is more than 36 percent. Obviously, this level of potential savings makes it a smart move to take the discount, even if money must be borrowed to do so.

On the other hand, can a veterinary practice afford to offer clients a discount for prompt payment?

Examine your cash flow

That depends on what it costs a veterinary practice to offer a prompt-payment discount. You usually can determine the cost by examining your cash flow.

Obviously, any credit terms you offer should be designed to improve your cash flow.

In order to speed the inflow of cash, some veterinarians offer a discount — typically 1 percent or 2 percent — off the original bill if payment is made early, usually within 10 days. Full payment normally is due within 30 days.

To discount or not to discount

To determine whether to offer discounts, analyze your practice's cash flow and bottom line. Your goal? To improve cash flow without sacrificing much profit.

Consider this hypothetical situation:

Although John Doe's practice has been experiencing a steady build-up in accounts receivable, slow collections have put a strain on his cash flow.

He is looking into the feasibility of changing credit terms by offering a discount if payments are received within 10 days. He requires full payment in 30 days.

Let's assume billing average totals about $25,000 per month. About 50 percent of Doe's clients would take advantage of a 1 percent discount and 75 percent would take advantage of a 2 percent discount, while the rest pay within 30 days.

Note: In Table 1, average accounts receivable is computed as a weighted average of the accounts receivable for the month. Cost of the trade discount is computed as follows: percent of patients/owners taking discount x monthly sales x discount percentage x 12 months.

Based on the figures of our hypothetical practice, offering no discount has the smallest impact on the bottom line, reducing profits by $2,750. Offering a 2 percent discount is the most costly, reducing the bottom line by $5,417.

From the cash-flow perspective, a lower average investment in accounts receivable means a quicker inflow of cash. Offering the 2 percent discount significantly reduces the practice's average investment in accounts receivable. This option would have the most favorable impact on cash flow problems.

Naturally, offering no discount is the most profitable, but does nothing to increase cash flow. Offering the 2 percent discount would significantly increase cash flow but at the expense of the bottom-line profit.

Obviously, in this situation, a 1 percent discount reduces the practice's bottom line by only $583, a small sacrifice for an $8,334 increase in cash flow.

Profiting from supplier discounts

If a supplier offers payment terms extending beyond 30 days, it may be more advantageous to skip the discount and delay payment until the full amount is due.

Generally, however, veterinarians should take advantage of discounts of 1 percent or more when offered by suppliers requiring full payment within 30 days.

To decide, compare the amount saved by taking the discount to the cost of borrowing money to make an early payment.

Naturally, the amount of the discount and the time in which it is available can vary greatly. Usually, trade discounts are based on what is common for the supplier's line of business. Some may offer a generous discount, others none at all.

One step further

Supplier discounts can be negotiable. Consider the potential rewards:

Many professionals have realized significant savings by negotiating standard payment terms of 30 to 45 days. Others have encouraged suppliers who did not normally offer discounts to give one in return for immediate payment, or by paying a bit more slowly when they did not.

In other words, some veterinarians created their own payment terms.

So, does it make sense to routinely overlook or ignore discounts? The answer should be obvious.

Battersby is a financial consultant in Ardmore, Pa.