How to Calculate Settlement Discount? A Guide
Different businesses all over the world offer various types of discounts. It can be for certain products that they offer or for a service that their customers purchase. Discounts are a great way to help entice customers to make a purchase from your business.
It can be a very effective sales technique to try and increase sales revenue. Some businesses offer discounts at a list price during certain holidays. Others might have a discount program for loyal customers.
Below you will find everything you need to know about settlement discounts and how to calculate them.
Here’s What We’ll Cover:
What Is a Settlement Discount?
How to Calculate a Settlement Discount
What Is a Settlement Discount?
A settlement discount can often get referred to as cash discounts or prompt payment discounts. They’re offered to customers when they purchase something from you to help complete the business transaction. Settlement discounts are often used in business-to-customer (B2C) transactions.
As well, a settlement discount is commonly used in various business markets. In this case, a business would purchase a product on credit. Then, their customers pay the funds that are due at a future date. The primary purpose of settlement discounts is to encourage your customers to pay as soon as possible.
When a customer makes a purchase, that transaction gets listed in your accounts receivables, since it’s a current asset. If your customers take too long to pay, then funds get tied up and you could potentially face liquidity issues.
Therefore, as mentioned above, a settlement discount is offered to the customer to entice them to pay as soon as possible. For example, you might offer your customers a 10% discount if they’re able to pay off and settle their debts within a certain timeframe.
Is a Settlement Discount Different from a Trade Discount?
What are the differences between a settlement discount and a trade discount? It all depends on when you grant the discount. Both types of discounts help with increasing sales revenue. They also contribute to maintaining a positive relationship with customers.
Trade discounts are intended to encourage a customer to purchase more at the time of a sale. The discount can increase the more a customer purchases. For example, let’s say that you offer your customers a discount for purchasing one item and issue a customer invoice.
They can then receive a higher discount if they purchase additional items. So, if they were offered a 5% discount for one item, you might offer a 10% discount for purchasing 10 items at once.
How to Calculate a Settlement Discount
The first thing to keep in mind when calculating a settlement discount is the original invoice terms. You would issue an invoice for the amount in full and then issue a credit note for the discount. Make sure that you clearly display the terms and the discount percentage on the invoice.
The steps to issue a settlement discount would look like this:
- Invoice the customer
- Record the payment
- Raise a credit note for the amount of the settlement discount
- Allocate the proper credit to the issued invoice
You calculate a settlement discount based on the increase in purchases from the customer. You could invoice a customer for making a purchase of X amount, but offer an additional 5% discount if the customer pays that amount within 7 days. These can also get referred to as discount days.
If the customer decides to accept the settlement discount, then they would only pay 95% of the original X amount. Keep in mind that if they do accept the discount, the invoice will look as though it’s underpaid.
To fix this and clear the invoice, you just need to raise a credit note. But, make sure that the amount of the credit includes VAT.
Key Takeaways
Offering discounts to your customers can have a ton of different benefits. Not only can you increase sales, but you can increase customer loyalty. And, with a settlement discount, it can also help in other areas.
For example, the more invoices that you issue might lead to customers taking longer to pay off their debts. This can have negative consequences on things such as cash flow and liquidity. It’s also worth noting the difference between trade discounts and settlement discounts.
A trade discount is applied if your customers purchase additional items from you. A settlement discount is applied if your customers decide to pay off their debts within the specified timeframe. This benefits profit margins, provides favourable payment terms and lets you settle transactions.
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