What does 2/10 net 30 mean? A Breakdown of Early Payment Discounts on Trade Credits
Although an invoice states balance owed, more often than not, it’s possible to negotiate paying less. Efficient accounts payable processing to achieve early payment discounts helps your small business or enterprise save money.
An invoice states the terms of a transaction, such as the credit terms, between the seller (also called a payee) and the buyer (also called the payer). A typical credit term is net 30, which means the balance is due within 30 days from the invoice date.
What is 2/10 net 30?
2/10 net 30 is a term that means buyers are eligible to receive a 2% discount on trade credit if the amount due is paid within 10 days. After the first 10 days, the full invoice amount is due in 30 days without the 2% discount according to the terms for 2/10 net 30.
How do you calculate 2/10 net 30?
This example calculates how much the credit customer pays.
Invoice full amount: $500
Invoice date: June 1
Invoice due date: 30 days
Payment terms: 2/10 net 30
Discount period: 10 days
Begin counting days from the day after the invoice date.
A quick formula is 100% – discount % x invoice amount.
100% – 2% = 98% x $500 = $490.
| Date of invoice payment | Number of days before paying | Early payment discount % | Discount amount | Payment amount due |
| June 1 through June 11 | 0 – 10 | 2% | $10 | $490 |
| June 12 through July 11 | 11 – 30 | 0% | $0 | $500 |
What are trade credits?
Trade credit is interest-free financing from a vendor. A customer pays later for billed purchases. In accounting, it’s accounts payable or trade payables.
Vendors sometimes include an interest rate for late payments made after the due date in payment terms. But suppliers may not collect these late payment finance charges on trade payables.
What is the Net method for trade credit accounting?
Record invoice balance less discount as one net amount. The customer records a credit purchase and accounts payable. The vendor records the credit sale and accounts receivable.
$500 – $10 discount = $490 net amount recorded
This example shows the transactions, often automated using accounting software.
To record a purchase when the customer receives the goods:
Purchases: $490
Accounts payable: $490
To pay the invoice included in the accounts payable balance early:
Accounts payable: $490
Cash: $490
If the company doesn’t pay early, then the entry is:
Accounts payable: $490
Purchase Discounts: $10
Cash: $500
Purchase discounts is a contra account to purchases, but increases purchases if not paid early.
What is the Gross method for trade credit accounting?
Record invoice amount and discount in separate accounts. Customer tracks total discounts taken or vendor tracks discounts given. The amounts reduce purchases for buyers or sales for sellers.
This example shows bookkeeping for transactions for a customer purchase.
To record a purchase when the customer receives the goods:
Purchases: $500
Accounts payable: $500
To pay the invoice included in the accounts payable balance early:
Accounts payable: $500
Early payment discounts on purchases: $10
Cash: $490
This early payment discount account is a contra-account, reducing purchases.
From the seller side:
The seller initially records sales and accounts receivable at the total amount. If the customer pays early, the seller records the sales discount as a debit in the sales contra-account called sales allowances. Sales allowances reduce sales in the income statement.
What are buyer-initiated early payment programs?
A buyer-initiated early payment program is managed through accounts payable with either the dynamic discounting method or supply chain finance method.
When the seller doesn’t offer cash discounts for prompt payment, buyers can negotiate for an early payment discount. If buyers propose a beneficial offer, by accepting, sellers will accelerate their cash flow. And buyers would reduce spending.
Dynamic Discounting Method
Dynamic discounting describes when buyers initiate an early payment offer on an invoice-by-invoice basis with varying discounts. The buyer could offer a 2 percent discount to one seller and a 1.3 percent discount to another. Buyers adopting dynamic discounting can leverage their excess cash.
Supply Chain Method
With the supply chain finance method, the buyer borrows funds from a trade credit financer to pay the invoice under the early payment credit term, such as 2/10 net 30. The buyer will need to pay back the third party bank or other financial institution since this method is essentially a loan. This corporate finance technique provides flexibility when cash balances are low.
What are some other trade terms like 2/10 net 30?
These payment terms on vendor and supplier invoices are defined in a similar way to 2/10 net 30:
2/10 net 45 means 2% early payment discount within 10 days or total amount of invoice due in 45 days.
3/10 net 30 means 3% early payment discount within 10 days or total amount due in 30 days.
3/20 net 60 means 3% early payment discount within 20 days or total amount due in 60 days.
2/EOM net 45 means 2% early payment discount if paid by the end of the month or total amount due in 45 days.
Net 20 EOM means the total amount is due for full payment within 20 days after the end of the month.
On credit sales, vendors offer a 2 percent discount most often to customers. Some vendors charge interest or financing charges on overdue bills per invoice terms.
When implementing an early payment program with either the dynamic discounting or supply chain finance method, companies will find it’s easier said than done. The rub lies in the efficiency of the accounts payable workflow. Businesses that have manual accounts payable processes will face these common challenges regarding early payment discount:
- Lengthy invoice approval process: the time between receiving the invoice to approving the invoice is often outside the timeframe of the of 2/10 net 30, which prevents the buyer from taking advantage of the discount.
- Lack of data: buyers must negotiate an offer that’s attractive to the seller and makes a difference in the company profit margin. In other words, the discount needs to be mutually beneficial. Finding that sweet spot takes visibility into several variables: buyer hurdle rate, discounting liquidity constraints, availability of third-party financing, and more. Manual accounts payable processes make it hard for companies to have deep visibility into these variables across all vendors.
- Weak buyer-seller relationship: implementing an early payment program takes adoption from both the buyer and the seller. Building the relationship between accounts payable and the seller can be challenging if the only contact occurs during the onboarding process when sellers submit tax documents. The lack of real-time visibility into the status of a payment hinders the buyer’s ability to give an accurate timeframe for payment delivery, which can affect the seller’s attitude and trust toward joining an early payment discount program.
When to use the early payment discount
Early payment discounts often make sense for buyers with cash balances or access to financing like a line of credit or supply chain method financing. The buyer should compare any interest rate to the opportunity cost of not taking the discount. The seller receives cash and collects accounts receivable faster when the customer pays early.
