What is Dynamic Discounting?

What is dynamic discounting?

Dynamic discounting is a payment policy where suppliers receive payments earlier than the agreed-upon terms. This happens when customers pay in advance in response to discounts offered on early payments. The process entails incentivizing customers, allowing improved asset liquidity and overall revenue. Dynamic discounting offers freedom for vendors to get paid whenever they want to get paid in exchange for a reduced price on goods/services purchased. In this scenario, dynamic refers to the variability of discounts based on payment dates to suppliers. In general, earlier payments lead to greater discounts.

The concept of dynamic discounting is applied on an invoice-by-invoice basis, where the discount expresses a percentage of the face value of the invoice processed. Buyers usually use their own cash to pay for the program upfront. This allows access to purchasing discounts. As a result, the return on funds is higher in the form of discounts than what they would earn by keeping that amount in savings.

Dynamic discounting is similar to supply chain finance, but it varies in the sense that the buyer finances instead of a third-party intervention. For instance, a supplier offers a 15% discount to customers who pay within 10 days instead of 30-day payment terms. This allows them to pay earlier while still facilitating the supplier to earn on the transactions.

Dynamic discounting facilitates both the buyer and the supplier, as they may take advantage of low-cost funding and use working capital for investments and development initiatives. Whereas, buyers are given a risk-free return on unspent funds.

Example of dynamic discounting:

Early Payment Discount—Fixed Terms

Scenario:

• Invoice amount: $10,000
• Standard payment terms: Net 30 (due in 30 days)
• The supplier offers a 15% discount if payment is made within 10 days.

What happens:

• The buyer pays on Day 10.
• Buyer pays only $8,500.
• Buyer earns a $1,500 discount.

This early payment acts as a risk-free return on the buyer’s excess cash.

In what ways does dynamic discounting work?

Dynamic discounting allows customizable discounts with automation. Suppliers gain complete control over discounting terms and tailor incentives to customers or transactions as per business needs. Dynamic discounting can be implemented in tier-based models, specialized offers on high-value transactions, and more. Here are a few steps involved:

Key mechanism of dynamic discounting:

Customizable terms

The supplier sets a variable discount rate based on how early a buyer pays. This can include:

• Tiered discounts (for example, 2% if paid in 20 days)
• Sliding scale models where discounts minimize near to due dates
• One-time promotional discount on large transaction invoices.

Supplier Control

Suppliers can decide whether to offer discounts, which invoices are eligible, and what the minimum acceptable payment periods are.

Automation

In robust payment platforms, often SaaS domains, discounting rules are embedded into automated workflows. Thus, the system matches invoices to discount opportunities. Moreover, real-time calculations are made based on payment timing. Also, buyers are notified when discounts are available.

Buyer participation

The buyer reviews open invoices and selects which ones to pay early based on funds availability. Then they execute early payment to avail the associated discount.

Settlement and accounting

The discount is automatically applied, and the transaction is reconciled in both parties’ financial systems. Reporting is updated to reflect savings and improved cash flow.

What are the different types of dynamic discounts?

Static discounting, sliding scale discounting, tiered discounts, on-demand supplier discounts, buyer-initiated offers, promotional discounts, and AI-driven discounts are some types of dynamic discounts. Here is a detailed explanation of each as follows:

Static discounting

It is a fixed discount that is offered on early payments for a product/service within a specific time period. For instance, a 2% discount is offered if payment is made in 10 days. This method enables simplicity and predictability in cash management.

Sliding Scale Discounting

It is a discounting type that varies based on the exact payment date, and the earlier the payment, the higher the discount. For example, Day 5 = 2.5% discount, Day 10 = 2%, and Day 20=1% discount.

Tiered Discounting

In this type, discount levels are set based on predefined time brackets. For instance, pay within 7 days = 7% discounts; pay within 14 days = 1.5% discounts.

On-Demand Discounts

In this case, the supplier offers discounts only when they seek early payment owing to their own cash flow needs. These are best when suppliers require control and flexibility over their cash flows.

Buyer-initiated offers

In this case the buyer proposes early payment in exchange for a discount, often automated through a platform. It best works when buyers are seeking to deploy excess cash for higher returns.

Ad hoc discounts

These are limited one-time offers applied to specific time periods and invoices. For instance, a 4% discount on all invoices over $50,000 paid in a quarter.

Automated discounts

Platforms employed by businesses often use machine learning and business rules to dynamically set and adjust discounts in real time.

What are the benefits of dynamic discounting?

Dynamic discounting benefits for suppliers include boosted working capital, access to low-cost funding, improved cash forecasting, and choice of invoice financing.

Here is a detail of each:

Boosted Working Capital

With early payments, suppliers can easily reduce days sales outstanding and enhance the cash conversion cycle.

Low-cost funding

Suppliers gain access to lower-cost funding than the other available options. This helps to manage unforeseen costs or improve their product/services via innovative solutions.

Improved cash forecasting

Suppliers have the authority to decide upon when to get paid, thus easing future strategic forecasting and cash flow planning and budgeting.

Invoice financing

Suppliers can opt for financing single, several, or all invoices as per requirement.

Benefits for Buyers

On the part of buyers, dynamic discounting benefits by offering risk-free return, cost savings, supply chain improvement, and improved supplier terms.

Cost reduction

By using early payment discounts, customers bring down the price of the goods and services they buy, which can help support procurement KPIs.

Empower supply chain wellbeing.

Providing customers with the ability to make early payments strengthens your supply chain and lessens the chances of any disruption.

Improve relationships with suppliers

Relationships between suppliers can be improved when they are given early payment, along with access to an easy-to-use platform.

Attractive risk-free returns

Through dynamic discounting, buyers are in essence making their own money available to take discounts, and these amount to risk-free returns greater than what is typically provided by conventional investment.

What is the difference between dynamic discount and supply chain finance?

Dynamic discounting is buyer-friendly early payment for a discount, whereas supply chain finance allows third-party funding to pay suppliers early without affecting the buyer’s cashflow.

Although both methods target improved cash flows, direct negotiations without third-party intervention in funding make dynamic discounting different. In other cases, supply chain finance involves third-party financing where a financial institution is involved that pays the supplier on the buyer’s behalf.

Dynamic discounting allows a simpler approach to payments, improving buyers’ profitability and offering a win-win for buyers and suppliers. While both improve supplier liquidity and working capital, dynamic discounting is a direct self-funded model, while supply chain finance relies on external party funds.

Example:

Dynamic Discounting:

A buyer owes $100,000 with 30-day terms. The supplier offers a 3% discount if paid within 10 days. The buyer pays $97,000 on day 10 using their own funds and saves $3,000.

Supply Chain Finance:

A buyer still has 30-day terms, but a bank pays the supplier $100,000 on day 10. The buyer pays the bank on day 30. The supplier gets paid early, and the buyer maintains cash flow flexibility.

What are the best practices for effective dynamic discounting?

Assessing cash flow needs, negotiating, using automation, assessing performance, and open communication are among some dynamic discounting best practices.

Assessment of cash flows

It is crucial to evaluate your cash flow needs in conjunction with accounts payable software to figure out the requirements and flexibility of early payment discounting.

Negotiation

Suppliers must understand the market condition and buyer interests and negotiate favorable terms for creating mutually beneficial discounts and payment terms. It helps ensure that they align with accounts payable automation strategies.

Automation

Use of automated discounting software to manage accounts receivable and payable is important. Implementation of the right automation technology can streamline the discounting process and allow accuracy and an overall improved discounting process.

Performance assessment

Regular review and monitoring of discounting performance is crucial. You must identify areas for improvement, any challenges from the customer’s side, and resolve any bottlenecks in the discounting process.

Communication is key

Keeping buyers and suppliers on the same page can help mitigate chances for miscommunication between them on payment terms and discounts offered. It offers financial clarity and trust-building in business relationships.

What are the challenges of dynamic discounting?

Dynamic discounting challenges include reduced revenue for vendors, cash cashflow constraints for buyers, limited discount opportunities, technical complexity, and imbalance in buyer-supplier power dynamics. Here is a detailed explanation for each of the challenges:

Revenue reduction

One notable drawback of dynamic discounting is the reduction in revenue per invoice when offering early payment discounts. Even though receiving payments sooner can improve cash flow, the trade-off is often a lower total amount received. For instance, a 2% discount on $100,000 means forfeiting $2000 in potential earnings. In case of thin profit margins, this can prove to be unfavorable.

Cash flow constraints

Buyer cash flow availability is a critical factor when considering early payment discounts. While cash-rich companies can afford to take advantage of these discounts, businesses operating with tight working capital or irregular cash inflows may face liquidity challenges. In some cases, aggressively pursuing early payment discounts can leave buyers short on cash for other essential expenses, such as payroll or inventory restocking.

Limited discount opportunities

Not all suppliers agree to dynamic discounting or offer early payments. Suppliers having strong cash reserves, stable financing, and low urgency for working capital may opt for declined early payment offers. This inconsistency for buyers will create issues, as some buyers would not participate in discount facilitation.

Technical complexity

Staff trainings, technological know-how integration, and workflow changes are all factors that must be considered when implementing dynamic discounting. Without proper automation, managing dynamic discounting manually can increase error risks, miscommunication, or missed discount opportunities. Small-scale companies may find it costly to manage these complexities efficiently.

Shift in power dynamics

In the case of industries where buyers hold negotiating power, dynamic discounting may seem coercive. Sometimes suppliers may feel compelled to offer discounts even if it does not favor them. This strain can pose a long-term imbalance, frustrating the supplier. Moreover, it may impact supplier sustainability and the buyer’s own supply chain stability.