By: Denise Smith, CPA, CGMA- Senior Accountant
Do you pay your bills as they come in? Do you take any discounts offered for early payment? The answers to these questions are important since they can save you money.
Most invoices from vendors come in with payment terms specified. Some examples are Net 30 days; Net 10 days; 2/10, Net 30; 1/10, Net 30, etc. Net 30 and Net 10 simply mean that the invoices are due 30 days or 10 days from the date on the invoice. 2/10, Net 30 and 1/10, Net 30 describe discounts that are offered if the invoices are paid within 10 days – either 2 % or 1%. If the discounts are not taken, the entire invoice amount is due in 30 days.
If you take the time to break down the numbers, you will see that taking a discount, if you have the cash available, will save you considerable amounts of money. For example, if you have an invoice for $1,000 with terms of 2/10, net 30 – you can pay only $980 and save $20. If you would have this invoice each month of the year, you would save $240 in a year. Break that down in terms of an interest rate and you get a calculation that looks like this: approximately 360 days in a year, paying 20 days early divides into the 360 days 18 times – which equates to 18 times the 2% discount rate or approximately 36%. Obviously, the rate would be lower for lower discount rates, but still, who wants to turn down a rate of return of 36% or 18% for a 1% discount. Another way to state the formula above is:
Discount %/( 1-Discount %) * 360 days/ Number of days of early payment
2%/.98 % * 360/20 = 36%
When a vendor has terms of net 30 or no stated terms on the voice, are you paying it immediately? Why not wait to pay the invoice until it is due? You can still enter the invoice to be paid in your accounting software, but let your accounting software calculate the invoice due date, and wait until then to pay the invoice. This will allow for better cash flow. An efficient way to do this is to file your invoices to be paid by week, and then write checks just once a week for the invoices that are due or have a discount.
Holbrook and Manter would be glad to help you set up your accounting software and filing system to efficiently process your Accounts Payable. Fill out the contact form below to get started!