Prompt-pay discounts are great way to save money by paying your suppliers’ bills faster than the maximum time allowed by the vendors who offer them.
These discounts are often overlooked in the busy demands of day-to-day small-business management.
And while they may seem insignificant on any given invoice, add them all up at the end of the year, and they become meaningful savings. You’d be shocked to see what failing to take advantage of them is costing your business.
Let’s say you owe a vendor $1,000 for supplies or services. The vendor offers a 2-per-cent discount if you pay within 20 days, or the full amount within 30 days of the issue of the invoice (that’s calendar days, not business days).
That may not seem too exciting or much of a business decision. In that example, just $20 hangs in the balance.
But now start factoring in all the bills that you pay. When they hit $10,000, that 2 per cent becomes $200. At $100,000, it’s $2,000. And at $1-million, it’s $20,000.
See how quickly that adds up?
Another way to look at it: Turn the calculation around and, if you don’t take the discount, you are effectively paying 2 per cent interest to your vendor for “borrowing” that money for the 10 days between the prompt-pay discount date and the maximum due date.
Paying 2-per-cent interest for 10 days doesn’t seem significant to you? Call me, then because I have a great deal on some Florida swamp land.
If you are really okay with paying 2-per-cent interest on a 10-day loan, consider this: Your effective annual interest rate is 102 per cent. \Can you borrow money cheaper than that somewhere else? Yes.
The truth is that you owe your vendors no matter how you slice it. Take the prompt-pay discount, save 2 per cent (or as I like to look at it, avoid paying an effective interest rate of 102 per cent and repeat.
Whatever you do, don’t let the invoice slide. Your vendor will probably start charging you interest on overdue amounts in the range of 2 per cent to 3 per cent. That’s an effective annual interest rate of 24 per cent to 38 per cent.
Ideally you have the cash to pay your bills early, but even if you have to dip into your line of credit or incur debt some other way, it is still cheaper than letting the invoice slide past the prompt-pay date.
You can test the value of my suggestion in your own business by adding up all of your business purchases last year from vendors that offer prompt-pay discounts, and see what the savings would be – and then see what the avoidance of “paying” that interest is worth.
Not taking advantage of prompt-pay discounts is costing your business a small fortune. Take them and you’ll profit directly -- and your vendors will be happier, as well.
Special to The Globe and Mail
Chris Griffiths is the Toronto-based director of fine tune consulting, a boutique management consulting practice. Over the past 20 years, he has started or acquired and exited seven businesses.
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