Trade and cash discounts are essential tools that you can implement to help boost sales and increase profitability. Such discounts are also an essential component for good inventory control, and can be used when it is necessary to sell large amounts at once or to reduce inventory in a short time frame.
There are key differences between a trade discount and a cash discount, which are important to recognise for business purposes. Here, we examine the key features of both a trade and cash discount, and explain the pros and cons of both.
A trade discount is offered by suppliers of goods or services. It is a reduction of the overall cost of list or catalogue prices of the goods in question. These types of discounts are often considered when there are large orders, and it is allowed on both cash and credit transactions.
This type of discount is given on the basis of a purchase, and it is not shown separately in account books. All amounts recorded in a sales or purchase book are done in the net amount only.
For example, imagine that a freight company purchases 10 trucks at a list price of $100,000 each. The total list price would be $1,000,000. If this purchase was given a 5% trade discount the total price after the trade discount would be $950,000.
A cash discount is given by a provider of services or a supplier of goods to the buyer, deducted from the invoice price. This discount is only allowed on cash payments, and it is often used as an incentive to pay a bill within a certain amount of time. A discount like this is given on the basis of payment, and it is shown separately in the Profit and Loss account.
Continuing from the example used for trade discounts, imagine that the supplier then also applies a 2% cash discount if the buyer pays within 10 days of delivery. Two percent of the invoice price would be $19,000, and therefore the total price would be $931,000.
Using trade or cash discounts are excellent ways to increase sales and, in turn, boost profit. Discounts like these attract customers and persuade them to buy more of what you are offering. A trade discount can encourage bulk sales, while a cash discount can facilitate prompt payment. Using trade discounts and cash discounts is the ultimate means for businesses to increase their sales revenue. Providing such discounts can also contribute to long-term customer retention, and it is a good way to attract potential clients as well.
Providing discounts can also contribute more generally to your inventory control plan. For example, if you find that you have an excess amount of stock, a trade discount can provide customers with an incentive to buy in bulk. Likewise, if you need to get rid of stock in a timely manner, a cash discount can be very useful.
While such discounts can be crucial to your business, there are some negative factors to consider. Trade discounts are used to increase purchase quantities, but they can also become a credit risk for the firm. Similarly, repeated, unchecked use of cash discounts can decrease the firm’s profit margin.
Regarding your inventory control plan, providing too many discounts at once or providing discounts too often may result in a stock deficiency, which can negatively impact your business. It is therefore essential that you factor in this potential when considering implementing discounts.