What is dynamic discounting?
Dynamic discounting is a solution that provides suppliers with the option of receiving early payment in exchange for a discount on their invoice. As a result, suppliers can typically access lower cost funding than they might otherwise receive, while harnessing working capital in order to invest in growth and innovation. Buyers, meanwhile, can gain an attractive risk-free return on their excess cash.
Dynamic discounting has some features in common with supply chain finance. Unlike supply chain finance, however, dynamic discounting is financed by the buyer rather than by a third-party finance provider.
The idea of early payment discounts is nothing new. But in the past, this tended to mean sticking to fairly rigid terms. A common example is 2/10 net 30, whereby the supplier offers the buyer a 2% discount if an invoice is paid within ten days. Otherwise, the buyer can pay in full at 30 days. Under this model, there is no discount available if the buyer pays after 12 or 15 days.
Today, dynamic discounting offers a far more flexible arrangement, allowing suppliers to get paid at any time between the invoice being approved, and the agreed payment term. The earlier the invoice is paid, the greater the discount the buyer receives.
How does dynamic discounting work?
While different dynamic discounting solutions will have different processes, most will include the following steps:
- Buyer purchases goods or services from supplier.
- Supplier uploads invoice onto the dynamic discounting platform.
- Buyer approves the invoice for payment.
- Supplier views the discounts on offer for a range of payment dates.
- Supplier accepts the preferred discount.
- Supplier receives payment on the chosen date.
Benefits of dynamic discounting
Both buyers and suppliers can benefit from the advantages that dynamic discounting offers in a number of different ways.
Benefits for buyers
- Attractive risk-free returns. By offering dynamic discounting, buyers are effectively investing their own cash in order to capture discounts – and these translate into risk-free returns which are often greater than the returns offered by traditional investment.
- Achieve cost savings. By taking advantage of early payment discounts, buyers reduce the cost of the goods and services they purchase, which can support procurement KPIs.
- Strengthen supply chain health. Offering customers early payment increases the resilience of your supply chain and reduces the likelihood of any disruption.
- Improve supplier relationships. Supplier relationships can be strengthened when suppliers are offered early payment, as well as access to a user-friendly platform.
Benefits for suppliers
- Boost working capital position. By receiving early payment, suppliers can reduce their days sales outstanding (DSO) and thereby improve their cash conversion cycle.
- Access low-cost funding. With dynamic discounting, suppliers typically gain access to funding at a lower cost than other options available to them, enabling them to handle unexpected costs or invest in growth and innovation.
- Improve cash forecasting. Suppliers can decide when to get paid, making it easier to forecast future cash flows and plan ahead.
- Choose which invoices to finance. With a flexible dynamic discounting solution, suppliers can choose whether to finance a single invoice, several invoices, or all invoices.
Dynamic discounting vs supply chain finance
Dynamic discounting and supply chain finance are often viewed as distinct solutions, implying a choice has to be made about which one to deploy as part of a working capital strategy. But that’s not really the case – in fact, dynamic discounting and supply chain finance can be used interchangeably to great effect.
With a complete working capital management platform like Taulia, you can access both solutions. That means you can switch seamlessly between self-funded dynamic discounting and third-party funded supply chain finance as your needs evolve. This could be particularly valuable if your funding requirements change or your business cycle means you only have surplus cash available at certain points in the year.
Dynamic discounting is a mechanism by which suppliers can accept early payment from the buyer in the transaction in exchange for a discount. This is different to factoring, a process through which the supplier sells its invoices to a third-party factor who is then paid by the buyer as per the original payment terms. Although both are perfectly viable methods of accelerating receivables collection and boosting short-term working capital, dynamic discounting doesn’t involve a third-party. The early payment is made directly by the buyer.
Dynamic discounting is differentiated from supply chain finance (also known as reverse factoring) in the same way as it is from regular factoring. Under supply chain finance, a third-party factor is prompted by the buyer in the transaction to make the payment to the supplier. The buyer then pays the factor in line with the original payment terms. Dynamic discounting involves no such third-party, with the buyer simply paying the supplier earlier in exchange for a discount.
Static discounting can be seen as the pre-cursor to dynamic discounting. It’s a discount mechanism used in supply chain transactions that involves a pre-set discount available to buyers for meeting certain payment terms. 2/10 net 30 is one of the most popular representations of a static discount, where the “2” refers to the percentage discount on offer, the “10” outlines how many days the discount is available for from the invoice date, and the “Net 30” represents the final payment due date.
Dynamic discounting accounting doesn’t fall under FASB rules and is relatively simple to understand. Since it’s a self-funded finance solution, there is no change to assets or liabilities beyond the outgoing payment itself, as there may be with other forms of financing. Accounting for dynamic discounting should in most cases be exactly the same as accounting for typical static discounts.