How expensive is a discount credit?
A supplier offers you to pay an invoice in full within 30 days or within 10 days with a 2% discount. Your bank charges 10% interest p.a. on overdrafts and 0% p.a. on current account balances.
Is it cheaper to pay the invoice later or within a week with a discount?
In order to be able to make a comparison, the difference between the two payment terms must be extrapolated to a full year. As there is a period of 20 days between the two periods, the interest saving of 2% must be extrapolated to 1 year. Assuming that a banking year comprises 360 banking days, the interest rate p.a. is therefore 2 % : 20 days x 360 days = 36 % p.a. If you also take into account that the interest on the payment amount reduced by 2% must be calculated using the cash discount, the interest rate is even slightly higher.
Result: In our example and in most cases, it is more favorable to make payments within the short payment period by taking advantage of the cash discount.
Cash discount is usually the cheapest
In our example, you only pay 10% interest p.a. for an overdraft at the bank, whereas you pay around 36% interest if you pay the due invoice later without a discount. The difference is therefore 26% p.a. If you have a (non-interest-bearing) credit balance at the bank, it is even more worthwhile to pay all incoming invoices with a cash discount (36% p.a.).
Which bills you should not (yet) pay
Here we explain why you should sometimes not pay invoices (immediately) for other reasons, even if you are offered a discount.
