Dynamic discounting

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Dynamic discounting describes a collection of methods in which payment terms can be established between a buyer and supplier to accelerate payment for goods or services in return for a reduced price or discount. [1]

Contents

Dynamic discounting methods are used for business-to-business transactions when contractual or pre-established early payment terms may not exist or the payment date does not conform to agreed upon discount terms. Dynamic discounting includes the ability to agree upon terms that vary the discount according to the date of early payment. The earlier the payment, the greater the discount. In addition, it includes an ability for either buyer or supplier to propose an early payment date and discount for a one-time payment using electronic mai l or specialized software. [2]

Through the use of dynamic discounting methods, buying organizations can increase the number and size of early payment discounts they receive and suppliers can get paid sooner at a lower cost of capital than alternative options. A range of concepts is available to implement dynamic discounting into supply chain finance (SCF): dynamic discounting can be seen as a comparatively simple form, whereby the supplier grants a cash discount for early payment of its invoices – the amount of the reduction and the time of payment are quickly and freely negotiable.

History

The opportunity to earn discounts in exchange for early payment in business-to-business commerce has been limited, historically, by the length of time necessary for accounts payable's to receive and approve paper invoices. An invoice that takes 20 days to be approved, for example, cannot be paid in time to qualify for a discount available from a supplier for payment on day 10. With the advent of electronic invoicing and Purchase-to-Pay (P2P) automation enabled by the Internet, buying organizations are increasingly able to approve invoices faster and take advantage of available discounts.

Dynamic discounting methods were invented and later patented by Xign Corporation [3] in the early 2000s to help businesses take advantage of these trends and establish early payment terms with suppliers. Since then software enabling dynamic discounts has become a common feature of procure-to-pay automation products. More recently, dynamic discount methods are being implemented via auction sites that enable buyers and suppliers to negotiate payment terms and discounts across large amounts of their spend. [4]

How does it work?

The buying organization offers to pay their suppliers early in exchange for a discount. The earlier the payment, the greater the discount.

Historically, it's not always been easy to achieve arrangements that work for both supplier and buyer and because of practical problems, it hasn't always been easy for buyers to actually pay early. But with the increased use of Purchase to Pay (P2P) technologies and methods there is now no reason why a buyer cannot pay promptly depending on how the collaborative arrangements with the supplier have been agreed.

An example of why dynamic discounting is beneficial to buyers is as follows. If a buyer receives a 2 per cent discount for early payment of an invoice—for example paying a 30-day-net invoice after 10 days. Therefore, instead of earning interest on the cash held in an account, it is “invested” for 20 days to get a 2 per cent return, This represents the equivalent of an over 36 per cent annual return on capital. While the early payment of the invoice would lead to a reduction in interest on the cash, the return for early payment far outweighs the loss of interest. That early payment may also be very valuable to the supplier who values cash flow more than high margins.

For many suppliers credit is difficult and/or expensive to secure. By working closely with customers and leveraging the power and flexibility of a P2P system, they can create a genuine synergy that reduces prices, the cost of borrowing and ultimately— the cost of doing business.

Features

Benefits

Dynamic discounting offers suppliers the flexibility of discounting some or all of their receivables, eliminating the need to use high-cost financing options like factoring or asset-based lending to obtain cash liquidity and stronger balance sheet positions. It also mitigates the uncertainty surrounding the timing and amount of payments, allowing for superior cash flow forecasting capabilities.

On the other hand, supplier financing can enable buyers to extend their payment terms with the injection of third party capital. These benefits accrue without adversely affecting trading partner relations. Dynamic discounting is based on a buyer's credit rating instead of being pegged to the supplier's risk, further strengthening buyer-supplier relationships.

Related Research Articles

In finance, discounted cash flow (DCF) analysis is a method of valuing a security, project, company, or asset using the concepts of the time value of money. Discounted cash flow analysis is widely used in investment finance, real estate development, corporate financial management and patent valuation. It was used in industry as early as the 1700s or 1800s, widely discussed in financial economics in the 1960s, and became widely used in U.S. courts in the 1980s and 1990s.

Financial market Generic term for all markets in which trading takes place with capital

A financial market is a market in which people trade financial securities and derivatives at low transaction costs. Some of the securities include stocks and bonds, raw materials and precious metals, which are known in the financial markets as commodities.

Trade credit is the loan extended by one trader to another when the goods and services are bought on credit. Trade credit facilitates the purchase of supplies without immediate payment. Trade credit is commonly used by business organizations as a source of short-term financing. It is granted to those customers who have a reasonable amount of financial standing and goodwill.

Pricing Process of determining what a company will receive in exchange for its products

Pricing is the process whereby a business sets the price at which it will sell its products and services, and may be part of the business's marketing plan. In setting prices, the business will take into account the price at which it could acquire the goods, the manufacturing cost, the marketplace, competition, market condition, brand, and quality of product.

Discounts and allowances are reductions to a basic price of goods or services.

Factoring (finance)

Factoring is a financial transaction and a type of debtor finance in which a business sells its accounts receivable to a third party at a discount. A business will sometimes factor its receivable assets to meet its present and immediate cash needs. Forfaiting is a factoring arrangement used in international trade finance by exporters who wish to sell their receivables to a forfaiter. Factoring is commonly referred to as accounts receivable factoring, invoice factoring, and sometimes accounts receivable financing. Accounts receivable financing is a term more accurately used to describe a form of asset based lending against accounts receivable. The Commercial Finance Association is the leading trade association of the asset-based lending and factoring industries.

Valuation (finance)

In finance, valuation is the process of determining the present value (PV) of an asset. Valuations can be done on assets or on liabilities. Valuations are needed for many reasons such as investment analysis, capital budgeting, merger and acquisition transactions, financial reporting, taxable events to determine the proper tax liability.

Accounts payable Money owed by business to its suppliers

Accounts payable (AP) is money owed by a business to its suppliers shown as a liability on a company's balance sheet. It is distinct from notes payable liabilities, which are debts created by formal legal instrument documents. An accounts payable department's main responsibility is to process and review transactions between the company and its suppliers and to make sure that all outstanding invoices from their suppliers are approved, processed, and paid. Processing an invoice includes recording important data from the invoice and inputting it into the company's financial, or bookkeeping, system. After this is accomplished, the invoices must go through the company's respective business process in order to be paid.

Accounts receivable Claims for payment held by a business

Accounts receivable, abbreviated as AR or A/R, are legally enforceable claims for payment held by a business for goods supplied or services rendered that customers have ordered but not paid for. These are generally in the form of invoices raised by a business and delivered to the customer for payment within an agreed time frame. Accounts receivable is shown in a balance sheet as an asset. It is one of a series of accounting transactions dealing with the billing of a customer for goods and services that the customer has ordered. These may be distinguished from notes receivable, which are debts created through formal legal instruments called promissory notes.

Financial transaction Form of agreement carried out between a buyer and seller

A financial transaction is an agreement, or communication, carried out between a buyer and a seller to exchange an asset for payment.

An invoice, bill or tab is a commercial document issued by a seller to a buyer, relating to a sale transaction and indicating the products, quantities, and agreed prices for products or services the seller had provided the buyer.

Net 10, net 15, net 30 and net 60 are forms of trade credit which specify that the net amount is expected to be paid in full by the buyer within 10, 15, 30 or 60 days of the date when the goods are dispatched or the service is completed. Net 30 or net 60 terms are often coupled with a credit for early payment.

Receipt Written acknowledgment that a person has received money or property in payment

A receipt is a document acknowledging that a person has received money or property in payment following a sale or other transfer of goods or provision of a service. All receipts must have the date of purchase on them. If the recipient of the payment is legally required to collect sales tax or VAT from the customer, the amount would be added to the receipt and the collection would be deemed to have been on behalf of the relevant tax authority. In many countries, a retailer is required to include the sales tax or VAT in the displayed price of goods sold, from which the tax amount would be calculated at point of sale and remitted to the tax authorities in due course. Similarly, amounts may be deducted from amounts payable, as in the case of taxes withheld from wages. On the other hand, tips or other gratuities given by a customer, for example in a restaurant, would not form part of the payment amount or appear on the receipt.

Working capital is a financial metric which represents operating liquidity available to a business, organization, or other entity, including governmental entities. Along with fixed assets such as plant and equipment, working capital is considered a part of operating capital. Gross working capital is equal to current assets. Working capital is calculated as current assets minus current liabilities. If current assets are less than current liabilities, an entity has a working capital deficiency, also called a working capital deficit and Negative Working capital.

Purchasing is the process a business or organization uses to acquire goods or services to accomplish its goals. Although there are several organizations that attempt to set standards in the purchasing process, processes can vary greatly between organizations.

Business valuation is a process and a set of procedures used to estimate the economic value of an owner's interest in a business. Here various valuation techniques are used by financial market participants to determine the price they are willing to pay or receive to effect a sale of the business. In addition to estimating the selling price of a business, the same valuation tools are often used by business appraisers to resolve disputes related to estate and gift taxation, divorce litigation, allocate business purchase price among business assets, establish a formula for estimating the value of partners' ownership interest for buy-sell agreements, and many other business and legal purposes such as in shareholders deadlock, divorce litigation and estate contest.

Treasury management includes management of an enterprise's holdings, with the ultimate goal of managing the firm's liquidity and mitigating its operational, financial and reputational risk. Treasury Management includes a firm's collections, disbursements, concentration, investment and funding activities. In larger firms, it may also include financial risk management.

The term Public eProcurement refers, in Singapore, Ukraine, Europe and Canada, to the use of electronic means in conducting a public procurement procedure for the purchase of goods, works or services.

PayMate is a business-to-business (B2B) payment solution provider headquartered in Mumbai.

Supply chain finance

Supply chain financing is a form of financial transaction wherein a third party facilitates an exchange by financing the supplier on the customer's behalf. Also it refers to the techniques and practices used by banks and other financial institutions to manage the capital invested into the supply chain and reduce risk for the parties involved.

References

  1. ↑ Zhong, Xiang; Zhao, Juan; Yang, Lu-Xing; Yang, Xiaofan; Wu, Yingbo; Tang, Yuan Yan (2018-12-28). "A dynamic discount pricing strategy for viral marketing". PLOS ONE. 13 (12): e0208738. doi:10.1371/journal.pone.0208738. ISSN   1932-6203. PMC   6310252 . PMID   30592727.
  2. ↑ Wang, Xiaojie; Zhang, Xue; Zhao, Chengli; Yi, Dongyun (2016-10-12). "Maximizing the Spread of Influence via Generalized Degree Discount". PLOS ONE. 11 (10): e0164393. doi:10.1371/journal.pone.0164393. ISSN   1932-6203. PMC   5061381 . PMID   27732681.
  3. ↑ Method and system for discount management - US Patent number 8,554,673; System and method for varying electronic settlements between buyers and suppliers with dynamic discount terms - US patent number 8,484,129; System and method for varying electronic settlements between buyers and suppliers with dynamic discount terms - US patent number 8,224,625.
  4. ↑ Camarero, Carmen; San José, Rebeca (2011-11-01). "Social and attitudinal determinants of viral marketing dynamics". Computers in Human Behavior. 27 (6): 2292–2300. doi:10.1016/j.chb.2011.07.008. ISSN   0747-5632.
  5. ↑ "CRX Markets". www.crxmarkets.com.
  6. ↑ "Dynamic discounting solving the late payments problem". itproportal.com.
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