Discounts are generally offered to encourage customers to pay faster; however, few security dealers or integrators have given much thought to either the cost of offering discounts to customers; and how much can really be saved by taking advantage of discounts offered by suppliers.
A business obviously benefits when customers pay promptly. Prompt payments from customers mean improved cash flow for the electronic security operation, a reduced need for borrowed working capital and far fewer collection problems. Little wonder, then, that so many businesses offer discounts and incentives to speed payments.
But are you overlooking the potential profits that can be reaped from the discounts offered by suppliers?
Taking Advantage of Discounts as a Buyer
Many security providers closely follow the old adage: always delay cash outflows. For a surprising number of electronic security business owners and managers, that means paying bills on time but never before they are due. In reality, however, most businesses would be better off paying a bill early in order to take advantage of the discount. Consider the math.
At one time, cash discounts were considered to be similar to interest for the use of money and were, accordingly, treated as an expense by the seller and as revenue by the buyer. Today, however, when cash discounts are offered by the seller, it is with the expectation that the customer will pay within the discount period. In effect, the seller is offering to make the sale for the invoice price reduced by the amount of the discount.
The supplier’s invoice usually includes credit terms, listing the period of time for which credit is extended, the size of the discount offered to those paying cash, and the date the credit period begins. A cash discount is a reduction in the purchase price provided the buyer pays within a specific period.
A typical supplier’s credit terms may be stated as “2/10 net 30.” A buyer reads the terms as a two percent discount if the invoice is paid within 10 days. Otherwise, the balance is due in 30 days. Why should anyone pay quickly in order to take advantage of a mere two percent discount?
Assume that a business has been extended credit terms of 2/10 net 30 on a $1,000 supplies purchase. By deciding to take the discount, the business will pay $980 ($1,000 less 2 percent). By ignoring the discount, the full cost of $1,000 will be paid within the month.
The decision not to take the discount means the buyer is paying $20 to keep the money for an extra 20 days. Because there are slightly more than 18 20-day periods in a year, the interest cost – on an annual basis – amounts to more than 36 percent. Obviously, this level of potential savings makes it a smart move to take the discount, even if money must be borrowed in order to do so.
As a general rule, every security dealer, reseller and system integrator should always take advantage of discounts of one percent or more when offered by suppliers that require full payment within 30 days. If the supplier offers payment terms extending beyond 30 days, it may be more advantageous to skip the discount and delay payment until the full amount is due.
Of course, in order to decide more precisely when to take advantage of a discount, the secuity provider must compare what would be saved by taking the discount, comparing it to what it would cost to borrow the funds needed for an early payment to a supplier.
Naturally, the amount of the discount and the time in which it is available can vary greatly. To a large extent, most supplier’s discounts are based on what is common for the supplier’s line of business. Some suppliers may offer a generous discount and some will offer none at all.
Obviously, not every security dealer, reseller and integrator has enough clout with its suppliers to negotiate better payment terms and discounts. Fortunately, within the security industry, payment terms and discounts are usually negotiable.
One business realized significant savings by negotiating standard payment terms from 30 to 45 days. Others have encouraged suppliers who did not normally offer discounts to give one in return for immediate payment – or by paying slower when discounts were not forthcoming.
Offering Discounts to Customers
On the other side of the coin, there is the question of how any business can afford to offer its customers a discount for prompt payment?
The principal disadvantage of offering discounts is the cost to the security operation’s bottom-line profits that arises from lost revenue. Obviously, the cost of discounts must be weighed against the improved cash flow that can be expected.
In its most basic form, cash flow is the movement of money in and out of a business; thus, every security provider’s credit terms should be designed to improve the operation’s cash flow.
In order to speed up the inflow of cash into their businesses, some security providers offer customers a discount from the original sales price if the customer pays within a specified period. Discounts are typically one or two percent if the customer pays within 10 days. Full payment is normally due within 30 days for customers that decide not to take advantage of the discount.
Service Contract Discounts
From a customer’s perspective, buying equipment – whether a smartphone, oil burner, computer or security system – at a substantial discount is possible by signing a service contract. While these deals may not be bad for a comparison shopping customer, businesses that offer these discounts may beat their competition, but at what cost?
In the case of a residential or commercial security system, any deal may make sense if the customers’ choice of providers is limited to only a few competitors – and if competition is fierce. As mentioned, the best approach for the customer is to get quotes with and without service or monitoring contracts.
Weighing your Options
Offering discounts has both advantages and disadvantages.
Pro: The main advantage of offering discounts is that it shortens the average collection period – one of the biggest hurdles faced when attempting to improve the security operation’s cash flow.
Con: The primary disadvantage of offering discounts is the cost to the operation’s bottom-line profits as a result of lost revenues. Obviously, the cost of discounts must be weighed against the expected improvement in cash flow.
Also among the disadvantages associated with discounts is the increased time needed for billing and processing the receivables. In order to take full advantage of discounts, billing should take place as early as possible, which is generally the transaction date, shipping date, project completion date, etc.
When it comes to determining whether to offer discounts, a security dealer, reseller or integrator should view the situation from two perspectives: the bottom line perspective and the cash flow perspective. In other words, will a discount increase the operation’s cash flow or its profits?
Determining the bottom-line impact means looking at the operation’s gross profit margin – usually defined as gross revenue less the cost of goods sold or the cost of operations. If it is only 15 percent, the operation will not be around too much longer if it offers 20-percent discounts. Naturally, other operating costs such as commisions and selling, general and administrative costs as well as fixed costs such as rent, depreciation, etc., also play a role. While some of these costs may not count in the short run they will definitely become a factor in the long run.
If fixed costs are a significant portion of the security operation’s total costs, providing discounts can add to the bottom line – if they substantially boost volume.
But security providers must also know their customers. Are they sensitive to price? Business customers, with high margins are often relatively price insensitive. If that’s the case, the operation probably does not need to offer discounts; in fact, it may be prudent to selectively raise prices.
The option that strikes a balance between these two perspectives will help increase the security operation’s cash flow – without sacrificing bottom-line profits.
While it is difficult to quantify all of the factors, customers might avoid deals because of the length of the contract, volatile markets or the expectation of new or improved equipment of systems. But, the bottom line remains – will the security dealer, reseller or integrator bankrupt their business by offering unrealistic deals?
According to one recent survey, businesses spend anywhere from $8 to $20 to process and pay a paper invoice. Switching to an electronic system can cut that cost to about $2; however, it is taking advantage of prompt payment discounts that generated the most savings, adding up to an annual return on cash in the range of 24 percent to 30 percent. Thus, it is imperative that often overlooked or ignored discounts stay on your radar.
Mark E. Battersby is a freelance writer who specializes in tax-related issues. Please email him at [email protected].
