Cash discount is the amount that company provides to the customer to encourage them to pay before the due date.
The company sells goods and services to customers for cash. They will use the cash to pay for the purchase of raw materials, fixed assets, and pay to other parties. It is the main source of cash flow for the company to support its operation. Sale is the first item on the income statement that will Sale on credit is the process that company allows the customer to use the goods or service and make payment later. By using this method, it will allow the customer to consume goods or services even they lack cash flow. Most companies are struggling with cash flow management, so if they have a chance to purchase on credit, they will go for it. It will help to boost the sale of the company and the goods or services will be reached more people.
However, the seller of goods or services is also facing a cash flow issue. They need cash to pay for employees, suppliers,s and other parties. They are in a situation that requires to balance between increasing sales and cash flow management.
As the result, company designed a cash discount policy to encourage the customer to pay the cash as soon as possible. The company will provide a discount when the customer makes payment before the due date. The cash discount usually comes in the form of 2/10, n/30 which means that the customer will receive 2% if payment is made within 10 days after the invoice date. The payment is required to make in 30 days.
Record Cash Discount
To get a full understanding, we have to look at the full recording related to the transaction. When company sells goods or service to the customer, they have to record accounts receivable and sale revenue as follows:
It will increase the account receivable and sales on the income statement.
When the customer pays within the discount period, the company needs to provide a discount to them. When receiving payment, they have to record cash, cash discount, and account receivable.
Example of Cash Discount
ABC sells goods to customers for $ 50,000 with a credit term is 3/10, net 30. The customer will receive a cash discount of 3% if they make payment within 10 days after the invoice date, they allow the customers to owe up to 30 days. After 5 days, the customer pays the full amount to claim the cash discount.
When the company sells on credit, they have to record sales and accounts receivable.
When the customer makes a payment and entitle to receive the cash discount, the company has to record the following:
Benefit of Cash Discount
- Increase more sales: The credit sale will allow the customers to receive the goods first and pay later, the customer will not face the cash flow issue. They can use the goods to generate a sale and settle the accounts payable later.
- Increase cash collection: The cash discount will encourage the customers to pay early to entitle them to the discount. As the result, the seller will be able to collect more cash in the early time.
- Reduce Bad debt: As the customers settle the accounts receivable early, the company will reduce the risk of bad debt which will increase the company profit.