Cash discounts

Definition

Cash discounts are reductions in the invoice price offered by sellers to encourage early payment from buyers. These discounts benefit both parties by improving cash flow for sellers and reducing overall costs for buyers.

5 Must Know Facts For Your Next Test

1. Cash discounts are typically expressed in terms like '2/10, net 30,' which means a 2% discount is available if payment is made within 10 days; otherwise, the full amount is due in 30 days.
2. Offering cash discounts can improve a company's liquidity by accelerating cash inflows.
3. Buyers often take advantage of cash discounts to reduce their cost of goods sold and improve profitability.
4. Cash discounts are recorded as sales discounts on the seller's income statement and as purchase discounts on the buyer's income statement.
5. A common financial metric related to cash discounts is the effective annual rate (EAR), which calculates the annualized return of taking the discount.

Review Questions

• What does the term '2/10, net 30' mean in relation to cash discounts?
• How do cash discounts impact a company's working capital?
• In what financial statements are cash discounts recorded for sellers and buyers?

Related terms

Trade Credit: A financing arrangement where a buyer can purchase goods on account without paying immediately, typically with agreed-upon terms.

Working Capital: The difference between a company's current assets and current liabilities, used to measure short-term financial health.

Effective Annual Rate (EAR): A financial metric that expresses the annualized interest rate or return, accounting for compounding over multiple periods.