Discounts are an indispensable part of a business that relies on consumer retail and supply chain management. In a supply-chain system, discounts allow the players to incentivize the other party to beat the fierce competition. The discounts are offered based on the ARP and required cash flow. The discounting system was introduced in the traditional business setup to benefit cash-rich companies. These companies have enough liquid at their disposal to release in the market.
The purpose was to provide a better return on the cash than the prevailing bank offers. Most companies realized soon enough that the interest rate offered by banks on the deposited cash was negative and won’t beat the compounding inflation. On the other hand, discounting allows these cash-rich companies to yield a good return that could be reinvested in the business. Today, we have two prevailing discounting models in place.
The most common discounting model is the static model. Static discounting has been around since time immemorial. The biggest drawback of this system was the lack of flexibility. This was realized quickly by the supplier companies. In the case of static discounting, the duration and the rate of discount were fixed under the contract terms. So, to avail of the discount, buyers had to make the advance payment within the stipulated period once the supplier raised the invoice.
If the advance payment wasn’t made within that duration, the buyer had to make complete payment upon receiving the goods. This created a considerable gap between supply and payment, which created cash-flow issues, especially with start-ups and new companies. Some of these companies needed the cash to optimize funds and facilitate business operations to ensure the timely delivery of goods and services.
Moreover, the duration and discount rate was determined by the buyer, which put the supplier in a disadvantageous position. Thus, a need for a more efficient discounting system arose, which gave birth to the dynamic discounting module.
Today, modern businesses are integrating dynamic discounting modules in their supplier credit system. Dynamic discount allows for greater room and flexibility in the supply-chain financial management system.
Under the terms of this model, suppliers can raise the request for a discount at any point before the delivery, depending on the market activity and need for cash flow. Based on the duration of the advance payment, the discount rates are offered to the buyer. So, if a buyer makes the payment as soon as the invoice is raised, he will be offered a greater discount on the goods or services. In this article, we will explore dynamic discounting and learn everything there is about it.
What is dynamic discounting?
Before moving any further with the article, we must understand the basics of dynamic discounting. Most businesses working under a traditional setup do not understand the concept of this new principle. Therefore, in this part, we aim to educate our audience by simplifying this new business model. We have already discussed everything about static discounts in our introductory part.
To put things in perspective, dynamic discounts completely contrast with the static discount model. Dynamic discount is a business model wherein suppliers can raise advance payment requests at any point after raising the invoice and offer discounts in return. Unlike the static discounting model, in dynamic discounting, the rate is fixed by the supplier. This is a win-win situation for both stakeholders, especially if the buyer is cash rich.
Moreover, by integrating technology with this model, we can automate the entire process and eliminate the negotiation process that used to be the major cause of delayed deliveries. If your company is growing well in the market and you have excess cash in the company account, dynamic discounting will offer you a better return on the investment compared to the bank.
Moreover, you can take note of the accounts and finances and decide accordingly when to pay the supplier and how much discount to avail. The rate of discount, in this case, is inversely proportional to the days remaining in the final payment. For the suppliers, advance payment is a great way to raise interest-free capital in case of a deficit cash flow.
Additionally, suppliers can take note of their accounts and decide accordingly about the discount rate they want to offer at different points in the timeline. Suppliers can use the cash raised under this method to make investments in inventory, working capital, etc. To summarize, the dynamic discount is a business model where the discount generation system is automated. This helps in breaking the rigidity barrier of the static discounting model.
How does dynamic discounting work?
Now that we are clear on the concept of dynamic discounting, we must understand the process of integrating of this model into your business. Here is a guide on how dynamic discounting works:
- The buyer places the order for goods or services with the supplier.
- The supplier delivers the concerned goods or services and raises the invoice.
- The supplier also uploads the invoice on any dynamic discounting platform.
- The buyer signs in on the platform and approves the invoice.
- Once the invoice is approved, the seller offers payment terms and discounting rates and determines the final payment date.
- Depending on the cash available at their disposal, the buyer selects a payment method.
- The payment request is raised at the supplier, and he accepts the preferred payment and discount option.
- Finally, the supplier receives payment on the date the buyer chooses.
Advantages of dynamic discounting
Dynamic discounting is changing the supply chain landscape. Hence, it is important to know what this model brings to the table for buyers and suppliers. Here are some benefits of dynamic discounting for the concerned parties:
For the supplier:
- By receiving early payment, a supplier can reduce its Days’ Sales Outstanding factor and improve his organization’s working capital situation.
- Suppliers can raise funds cheaply and invest them in other ventures. Dynamic discounting is a great way to escape the web of expensive loans.
- The dynamic discounting platform allows the supplier to choose a payment timeline, which helps them plan their cash flow structure for the concerned financial year.
- The best thing about this model is that suppliers can choose the invoices they want to receive the advance payment. They may choose some or none of the invoices. This gives them a chance to manage their APR better.
For the buyer:
- Dynamic discounts are a great way for buyers to reduce the costs of goods and services. This allows for profit maximization.
- By availing early payment option, buyers invest their excess cash in a risk-free instrument.
- Early payment improves buyers’ credibility in the market.
Dynamic discounting vs. other models
In this part, we will highlight key differences between dynamic discounting and other discounting models.
- Factoring: Dynamic discounting differs from factoring because, here, the supplier is paid completely in accordance with the invoice, and a small discounting portion is deducted from the amount.
- Static discounts: Static discounting terms like 2/10 and net 30 are rigid because it means that 2% discount on advance payment within 10 days; otherwise, complete payment on the final date. On the other hand, the supplier can raise advance payment requests at any point before the final payment date under dynamic discounting. The discount rate differs depending on the duration.
- Supply chain finance: The key difference between supply chain finance and dynamic discounting is that in the case of supply chain finance, the invoice is funded by a third party. Therefore, supply chain finance improves the working capital quotient of the buyer, whereas dynamic discounting enhances the cost of goods and services for the buyer.
Dynamic discounting is efficient for businesses to maintain their cash flow. We know that in the supply chain, the time gap between the delivery of the product and the payment is quite huge.
Moreover, if the supplier is engaged in product manufacturing, this time gap widens even more. Therefore, dynamic discounting platforms allow the business to maintain cash flow to fund business operations and keep the employees’ morale high.