Trade discounting is important to know about for over production of inventory stock as it can really help you sell inventory stock that would otherwise be obsolete. It can also increase the quantities of inventory stock sold too. Here we explain what trade discounting is and reasons for using trade discounting.
What is trade discounting?
A trade discount is a reduction to the recommended retail price of a product. For example, a high-volume wholesaler might be entitled to a 50% trade discount, while a medium-volume wholesaler is given a 30% trade discount. A retail customer will receive no trade discount and will have to pay the listed price or recommended retail price.
Trade discounts are not prompt payment discounts given for early payment. Trade discounts are a common accounting term and are used to encourage sales, generally in large quantities.
Reasons for using trade discounting
Businesses produce goods and services with the main aim of selling these at a profit. The main idea is that if a business produces more, they can sell more and in turn increase their sales revenue. By producing more, you can sometimes benefit from economies of scale. Economies of scale is whereby a business is producing more, with the flow on effect being that your cost of production per unit decreases. This can however lead to over production. If a business has over estimated its demand for production it can often lead to inventory stock left unsold. Buyers may not wish to buy at present prices, however it is important for the seller to recover their money. Take for example a seller has his or her supplier to pay off soon and does not have the cash to do so. Over production then sometimes leads to sellers getting any price they can get for it to retrieve some revenue compared to nothing at all.
When a business offers their goods at a reduced price in order to tempt someone to buy, it is a discount that facilitates trade. A trade discount is generally given to a buyer who offers to purchase the goods in bulk, and generally is given towards the end of the season. In case of seasonal goods, the seller would not want to have a large inventory stock lying unsold especially when it will remain unsold, for a large part of the year. Hence the seller may have to offer a drastic cut in the price, if he or she is to tempt a prospective buyer into buying his or her goods. The arrangement is also used to tempt the buyer into buying a larger quantity of goods than he or she originally needs.
The trade discount is an arrangement that benefits both the seller and the buyer. The buyer in this case can get the goods he or she needs at a remarkably low price quite similar to discount shopping and the seller can get rid of the goods lying unsold in the warehouse, which would otherwise become obsolete, meaning they’re able to improves the company’s liquidity position.