Who Wins With Dynamic Discounts?

The digitization of payments between businesses opens up a whole world of possibilities with respect to invoicing and payment terms. Dynamic pricing –  where a buyer and supplier establish terms to accelerate payment in return for a reduced price or discount on the acquired goods or services – is one of those options. Knowing how and when to use it turns out to be a bit more complicated than it might first appear.

For instance, such pricing practices and trade terms potentially could become problematic as direct-spend volume rises among nonbanks. Specifically, dynamic discounting programs could have a significant impact on a corporation’s balance sheet, according to a recent Spend Matters article by David Gustin.

As Gustin explained, a company must determine where its discount revenue goes when it pays suppliers early and takes a discount with its own money.

“For example, if Mr. Multinational pays a large component supplier early, Mr. Multinational will take a 2 percent early-payment discount on a $10 million payment (and let’s assume it is a gross discount and not tenor based),” Gustin wrote. “Mr. MNC pays $9.8 million to the supplier and has $200,000 in discount revenue. Mr. MNC would have the general ledger entry of a credit for accounts payable and debit to cash.  Since they got $10 million in inventory, they have an offsetting $200,000 journal entry – do they reduce cost of goods sold, have a discount revenue account, reduce interest expense, or other?”

It becomes complicated when a third party pays a multinational corporation’s suppliers early, Gustin wrote. For example, a funding provider pays the supplier $9.8 million and then gives the corporation $40,000 as a rebate. The funding provider then makes $160,000 on the deal when the buyer pays the $10 million on value date.

In effect, the funder is loaning the large corporation money, generating the transaction by extinguishing the payable moving it to debt.  When the funder pays off the prepays to the supplier, it is generating a loan to Mr. MNC that should show on its balance sheet.

Last month, PYMNTS.com discussed e-invoicing research that elaborated on the importance of making the digital switch. In that report, Susie West, the founder and CEO of sharedserviceslink, said that the opportunities that e-invoicing enables – such as dynamic discounting and supply-chain financing – are the primary reasons why businesses should make the switch.

Essentially, West explained, e-invoicing must be seen as an enabler, or a means to an end. For example, when e-invoicing is incorporated, then businesses have the power and ability to reap other benefits, such as dynamic discounting.

That idea is similar to what Gustin underlined as a key factor in his Spend Matters article as well. Essentially, going digital is just the beginning, but once the process begins, companies will greatly benefit.

“Since we are still in early days with third-party funding, the dollars financed are not enormous,” Gustin wrote. “But we know funders are chomping at the bit to get at these assets, and when the amounts get larger, this is where the fun begins and the accountants will be making some money advising their clients.”