In
finance
Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of production, distribution, and consumption of money, assets, goods and services (the discipline of fina ...
, dynamic discounting describes a collection of methods in which
payment terms
Discounts and allowances are reductions to a basic price of goods or services.
They can occur anywhere in the distribution channel, modifying either the manufacturer's list price (determined by the manufacturer and often printed on the package) ...
can be established between a
buyer
Procurement is the method of discovering and agreeing to terms and purchasing goods, services, or other works from an external source, often with the use of a tendering or competitive bidding process. When a government agency buys goods or serv ...
and supplier to accelerate payment for
goods or services
Goods are items that are usually (but not always) tangible, such as pens, physical books, salt, apples, and hats. Services are activities provided by other people, who include architects, suppliers, contractors, technologists, teachers, docto ...
in return for a reduced price or
discount.
Dynamic discounting methods are used for
business-to-business
Business-to-business (B2B or, in some countries, BtoB) is a situation where one business makes a commercial transaction with another. This typically occurs when:
* A business is sourcing materials for their production process for output (e.g., a ...
transactions when
contractual
A contract is a legally enforceable agreement between two or more parties that creates, defines, and governs mutual rights and obligations between them. A contract typically involves the transfer of goods, services, money, or a promise to tran ...
or pre-established early payment terms may not exist or the payment date does not conform to agreed upon discount terms. Dynamic discounting includes the ability to agree upon terms that vary the discount according to the date of early payment. The earlier the payment, the greater the discount. In addition, it includes an ability for either buyer or supplier to propose an early payment date and discount for a one-time payment using
email
Electronic mail (email or e-mail) is a method of exchanging messages ("mail") between people using electronic devices. Email was thus conceived as the electronic ( digital) version of, or counterpart to, mail, at a time when "mail" meant ...
or specialized
software
Software is a set of computer programs and associated documentation and data. This is in contrast to hardware, from which the system is built and which actually performs the work.
At the lowest programming level, executable code consists ...
.
Through the use of dynamic discounting methods, buying organizations can increase the number and size of early payment discounts they receive and suppliers can get paid sooner at a lower cost of capital than alternative options. A range of concepts is available to implement dynamic discounting into
supply chain finance
Supply chain financing (or reverse factoring) is a form of financial transaction wherein a third party facilitates an exchange by financing the supplier on the customer's behalf. Also it refers to the techniques and practices used by banks and ...
(SCF): dynamic discounting can be seen as a comparatively simple form, whereby the supplier grants a cash discount for early payment of its
invoices
An invoice, bill or tab is a commercial document issued by a seller to a buyer relating to a sale transaction and indicating the products, quantities, and agreed-upon prices for products or services the seller had provided the buyer.
Payment t ...
– the amount of the reduction and the time of payment are quickly and freely negotiable.
History
The opportunity to earn discounts in exchange for early payment in business-to-business
commerce
Commerce is the large-scale organized system of activities, functions, procedures and institutions directly and indirectly related to the exchange (buying and selling) of goods and services among two or more parties within local, regional, nation ...
has been limited, historically, by the length of time necessary for
accounts payable's to receive and approve paper invoices. An invoice that takes 20 days to be approved, for example, cannot be paid in time to qualify for a discount available from a supplier for payment on day 10. With the advent of
electronic invoicing
Electronic invoicing (also called e-invoicing or einvoicing) is a form of electronic billing. E-invoicing methods are used by trading partners, such as customers and their suppliers, to present and monitor transactional documents between one anoth ...
and
Purchase-to-Pay
Purchase-to-pay, often abbreviated to P2P and also called ''req to check/cheque'', refers to the business process
A business process, business method or business function is a collection of related, structured activities or tasks by people or ...
(P2P) automation enabled by the
Internet
The Internet (or internet) is the global system of interconnected computer networks that uses the Internet protocol suite (TCP/IP) to communicate between networks and devices. It is a '' network of networks'' that consists of private, pub ...
, buying organizations are increasingly able to approve invoices faster and take advantage of available discounts.
Dynamic discounting methods were invented and later patented by Xign Corporation in the early 2000s to help businesses take advantage of these trends and establish early payment terms with suppliers. Since then
software
Software is a set of computer programs and associated documentation and data. This is in contrast to hardware, from which the system is built and which actually performs the work.
At the lowest programming level, executable code consists ...
enabling dynamic discounts has become a common feature of
procure-to-pay
Procure-to-pay (also known as Purchase to Pay (P2P)) is a term used in the software industry to designate a specific subdivision of the procurement process.
The P2P systems enable the integration of the purchasing department with the accounts pa ...
automation
Automation describes a wide range of technologies that reduce human intervention in processes, namely by predetermining decision criteria, subprocess relationships, and related actions, as well as embodying those predeterminations in machines ...
products. More recently, dynamic discount methods are being implemented via
auction
An auction is usually a process of buying and selling goods or services by offering them up for bids, taking bids, and then selling the item to the highest bidder or buying the item from the lowest bidder. Some exceptions to this definition ex ...
sites that enable buyers and suppliers to negotiate payment terms and discounts across large amounts of their spend.
How does it work?
The buying organization offers to pay their suppliers early in exchange for a discount. The earlier the payment, the greater the discount.
Historically, it's not always been easy to achieve arrangements that work for both supplier and buyer and because of practical problems, it hasn't always been easy for buyers to actually pay early. But with the increased use of
Purchase to Pay (P2P) technologies and methods there is now no reason why a buyer cannot pay promptly depending on how the collaborative arrangements with the supplier have been agreed.
An example of why dynamic discounting is beneficial to buyers is as follows. If a buyer receives a 2 per cent discount for early payment of an
invoice
An invoice, bill or tab is a commerce, commercial document issued by a sales, seller to a buyer relating to a sale transaction and indicating the product (business), products, quantities, and agreed-upon prices for products or Service (economic ...
—for example paying a 30-day-net invoice after 10 days. Therefore, instead of earning
interest
In finance and economics, interest is payment from a borrower or deposit-taking financial institution to a lender or depositor of an amount above repayment of the principal sum (that is, the amount borrowed), at a particular rate. It is distinct ...
on the cash held in an account, it is “invested” for 20 days to get a 2 per cent return, This represents the equivalent of an over 36 per cent annual
return on capital Return on capital (ROC), or return on invested capital (ROIC), is a ratio used in finance, valuation and accounting, as a measure of the profitability and value-creating potential of companies relative to the amount of capital invested by sharehold ...
. While the early payment of the invoice would lead to a reduction in interest on the cash, the return for early payment far outweighs the loss of interest. That early payment may also be very valuable to the supplier who values
cash flow
A cash flow is a real or virtual movement of money:
*a cash flow in its narrow sense is a payment (in a currency), especially from one central bank account to another; the term 'cash flow' is mostly used to describe payments that are expected ...
more than high margins.
For many suppliers
credit
Credit (from Latin verb ''credit'', meaning "one believes") is the trust which allows one party to provide money or resources to another party wherein the second party does not reimburse the first party immediately (thereby generating a debt), ...
is difficult and/or expensive to secure. By working closely with customers and
leveraging the power and flexibility of a P2P system, they can create a genuine
synergy
Synergy is an interaction or cooperation giving rise to a whole that is greater than the simple sum of its parts. The term ''synergy'' comes from the Attic Greek word συνεργία ' from ', , meaning "working together".
History
In Christia ...
that reduces prices, the cost of borrowing and ultimately— the cost of doing business.
Features
*Discount amount is calculated dynamically based on the number of days remaining until the due date
*Discounts do not need to be negotiated in advance, rather the buyer can set a
liquidity
Liquidity is a concept in economics involving the convertibility of assets and obligations. It can include:
* Market liquidity, the ease with which an asset can be sold
* Accounting liquidity, the ability to meet cash obligations when due
* Liqui ...
limit and interest rates and allow the supplier to dynamically take discounts as
working capital
Working capital (WC) is a financial metric which represents operating liquidity available to a business, organisation, or other entity, including governmental entities. Along with fixed assets such as plant and equipment, working capital is consi ...
needs dictate
*Trading parties can tap into a risk-free, alternative source of working capital with the use of third party creditors whom pay early on behalf of the buyer
Benefits
Dynamic discounting offers suppliers the flexibility of discounting some or all of their
receivables, eliminating the need to use high-cost financing options like factoring or
asset-based lending
Asset-based lending is any kind of lending secured by an asset. This means, if the loan is not repaid, the asset is taken. In this sense, a mortgage is an example of an asset-based loan. More commonly however, the phrase is used to describe lending ...
to obtain cash liquidity and stronger
balance sheet
In financial accounting, a balance sheet (also known as statement of financial position or statement of financial condition) is a summary of the financial balances of an individual or organization, whether it be a sole proprietorship, a business ...
positions. It also mitigates the uncertainty surrounding the timing and amount of payments, allowing for superior
cash flow forecasting
Cash flow forecasting is the process of obtaining an estimate or forecast of a company's future financial position; the cash flow forecast is typically based on anticipated payments and receivables.
See Financial forecast for general discussion ...
capabilities.
On the other hand, supplier financing can enable buyers to extend their
payment terms
Discounts and allowances are reductions to a basic price of goods or services.
They can occur anywhere in the distribution channel, modifying either the manufacturer's list price (determined by the manufacturer and often printed on the package) ...
with the injection of third party
capital
Capital may refer to:
Common uses
* Capital city, a municipality of primary status
** List of national capital cities
* Capital letter, an upper-case letter Economics and social sciences
* Capital (economics), the durable produced goods used f ...
. These benefits accrue without adversely affecting trading partner relations. Dynamic discounting is based on a buyer's
credit rating
A credit rating is an evaluation of the credit risk of a prospective debtor (an individual, a business, company or a government), predicting their ability to pay back the debt, and an implicit forecast of the likelihood of the debtor defaulting.
...
instead of being pegged to the supplier's risk, further strengthening buyer-supplier relationships.
*Allows buyers to pay their suppliers early in exchange for a discount.
*Allows buyers to benefit from double-digit, risk-free returns.
*Reduces large organizations annual spend by earning significantly more early payment discounts through additional discounts on non-discount invoices and maximum capture of traditional discounts.
*Strengthens the financial
supply chain
In commerce, a supply chain is a network of facilities that procure raw materials, transform them into intermediate goods and then final products to customers through a distribution system. It refers to the network of organizations, people, acti ...
and supplier relationships by providing suppliers with quick, easy access to cash.
*Fully integrated in / between two
ERP-Systems the supplier can benefit from the transparency of received invoices on the buyer-side and possibly even use an integrated advice of settlement as value ad in his payment cockpit *(e.g. SAP).
References
{{Reflist
Supply chain management