Latest / Cash Flow Conversations with Fexingo: Working Capital, Receivables, and Small Business Finance / How Dynamic Discounting Replaced Net-30 at One Supplier
Transcript
- Lucas: So there's this story from a mid-sized industrial supply company — we'll call them Allied Components, because the owner asked me not to use the real name. They had a problem a lot of small manufacturers know: one big customer, a national distributor, demanded Net-60 terms. And Allied, which usually ran on Net-30, didn't have the cash reserves to wait two months for payment on a six-figure order. Luna: Right, that's the classic squeeze. The buyer has leverage because they're the one placing the big order, but the supplier's the one who has to pay for raw materials and labor upfront. Lucas: Exactly. So instead of just accepting the Net-60 and then scrambling for a line of credit, Allied offered something else: a sliding-scale discount for early payment. The terms were — pay within 10 days, get 2 percent off. Pay within 20 days, get 1 percent off. Full price at 30 days, and Net-60 was still on the table as a baseline. Luna: So they effectively created their own early-payment incentive, but tiered. That's different from the standard '2/10 Net 30' where it's all-or-nothing. Lucas: Right. Standard trade credit terms often give a flat 2 percent discount if paid within 10 days, otherwise full amount in 30. But Allied added a middle tier, which gave the buyer more flexibility. And here's the key — they didn't just offer it to the national distributor. They rolled it out to their entire customer base. Within six months, 40 percent of their invoices were paid within 10 days or fewer, and their average receivables cycle dropped by 12 days. Luna: That's a significant improvement. But let's talk about the math. A 2 percent discount for paying 20 days early — because if Net-30 is the baseline, paying on day 10 versus day 30 means you're giving up 2 percent to get money 20 days sooner. What's the annualized cost or return? Lucas: It works out to about 37 percent annualized. Because 2 percent over 20 days — if you compound that over roughly eighteen 20-day periods in a year — you get a 37 percent effective annual rate. That sounds expensive for the supplier, right? But compare it to the alternative. Allied's line of credit was at prime plus 3, which at the time was around 8.5 percent. So paying 2 percent to get cash 20 days early is far cheaper than borrowing for two months at 8.5 percent on the full invoice amount. Luna: So it's actually cheaper liquidity than a bank loan, especially if you factor in that the discount is only taken by customers who pay early — not everyone takes it. Lucas: Exactly. And for the buyer, it's a fantastic return. If you're a purchasing manager and you can pay an invoice 20 days early to save 2 percent, that's a 37 percent annualized return on your cash. Most corporate treasuries would jump at that. Luna: But there's a risk. What if customers start gaming the system? Like, they take the 2 percent discount but still pay on day 29, or they take the discount on small invoices and stretch on large ones? Lucas: That's a real concern. Allied handled it by making the discount automatic only if payment was received within the window. Their accounting system flagged any payment that tried to take a discount outside the terms. And they communicated clearly: the discount is a courtesy for early payment, not a negotiation tactic. They had one customer who tried to deduct 2 percent on a day-35 payment, and Allied rebilled them for the difference. Luna: So you need systems in place to enforce it. It's not just a policy — it's an operational change. Lucas: Absolutely. And that brings me to something I think is worth noting for small business owners listening. You don't need to be a huge company with a fancy ERP to do this. Allied used QuickBooks with a custom field for discount terms, and they ran a weekly report of invoices paid within the discount window. Total cost to implement was maybe a few hours of setup time. Luna: But what about the big buyer who demanded Net-60 in the first place? Did they take the discount? Lucas: They did. The national distributor agreed to pay within 20 days at the 1 percent discount tier. For them, 1 percent for paying 40 days early — because Net-60 is the baseline, so day 20 versus day 60 is 40 days early — that's about 9 percent annualized. Not as juicy as 37 percent, but still better than their own cash sweep accounts were yielding at the time. And for Allied, they got their cash in 20 days instead of 60, which saved them from having to draw on that line of credit. Luna: So it solved the cash crunch without the cost of debt. I like that. But what's the downside? There's always a downside. Lucas: The downside is that you're leaving money on the table if your customers would have paid early anyway. Some companies have customers who pay reliably in 15 days regardless of terms. If you offer a 2 percent discount for 10-day payment and they were already paying in 15, you're essentially giving away 2 percent for nothing. So you need to know your actual payment patterns before you set the rates. Luna: Right. So the first step is to analyze your receivables aging. See who pays early, who pays on time, who pays late. Then segment your offer. Lucas: Exactly. And that's what Allied did. They found that about 30 percent of their customers were already paying within 15 days. For those, they didn't change terms. But for the ones paying in 30 to 60 days, they offered the sliding scale. And they also realized that the discount cost them about 0.8 percent of revenue in the first year, but it reduced their average days outstanding from 42 to 30. That freed up roughly 200,000 dollars in cash that would have been tied up in receivables. Luna: That's a huge improvement. And it's not just about the cash — it's about the predictability. When you know that 40 percent of invoices will be paid within 10 days, you can plan your payroll, your inventory purchases, your growth investments much more confidently. Lucas: Speaking of growth investments — I've been thinking about how much this show has changed how I think about my own finances. And I know a lot of listeners have told me the same. If these conversations have moved your work forward in some small way, the best way to keep them coming is to support the show directly. We keep it ad-free, and listener support is what makes that possible. You can do that at buy me a coffee dot com slash fexingo. Luna: Yeah, it's a small gesture that has a big impact for us. And it means we don't have to pitch you credit cards or software you don't need. So thank you to anyone who's already contributed. Lucas: All right, back to dynamic discounting. One more angle I want to touch on: how do you set the discount rate? Because it's not a random number. Allied looked at their cost of capital — the interest rate on their line of credit plus a buffer. They figured that if they could get cash faster at a cost lower than their borrowing rate, it was worth it. So they set the 2 percent tier to be roughly equivalent to the interest they would have paid on a 30-day loan, but with the benefit of no credit check and no paperwork. Luna: So it's a direct comparison: what does it cost me to wait for this money versus what does it cost me to incentivize early payment? And the answer depends on your specific borrowing rate. Lucas: Right. And for a business with a high cost of capital — say, a startup with a merchant cash advance at 30 percent — even a 3 percent discount for 20 days early might be worth it. But for a business with a cheap line of credit at 6 percent, a 1 percent discount might be too generous. You have to model it. Luna: And what about the psychological factor? Some buyers might see a discount as a sign of desperation — like, 'Oh, they need cash, let me squeeze them harder.' How do you avoid that? Lucas: That's a smart concern. Allied framed it as a partnership benefit: 'We want to pass on cost savings from our efficient operations to our best customers who pay quickly.' They positioned it as a reward for good behavior, not a cry for help. And they offered it to all customers equally, so no one felt singled out. Also, they didn't call it 'dynamic discounting' to customers — they called it 'early payment savings.' Language matters. Luna: That's a good lesson in messaging. You're not desperate; you're rewarding efficiency. And if the buyer is sophisticated, they'll recognize the win-win. Lucas: Exactly. And here's a final number that stuck with me: Allied calculated that for every 1,000 dollars in early payments they received, they saved about 30 dollars in avoided interest costs. That's a 3 percent savings on the amount. Over a year, with about 500,000 dollars in early payments, that's 15,000 dollars saved — just from not borrowing. Plus, they avoided the hassle of loan applications and covenants. Luna: So dynamic discounting is essentially a liquidity management tool that you control yourself, without a bank. It's like your own internal credit facility. Lucas: That's a great way to put it. And the best part is, it's reversible. If you find the discount is too costly, you can adjust the rates or the windows. You can test it on a subset of customers. You're not locked into a contract. For a small business, that flexibility is gold. Luna: So what's the one thing you'd recommend a listener do tomorrow if they want to try this? Lucas: Pull your receivables aging report. See what your average days outstanding is. Then calculate what it would cost you to wait that long — multiply your average invoice amount by your daily cost of capital. Then compare that to offering a 1 or 2 percent discount for payment within 10 days. If the discount cost is lower than the carrying cost, it's worth a pilot. Start with one or two customers who you trust, and see how they respond. Luna: And if they respond well, you've got a new tool in your cash flow toolkit. If not, you've only risked a couple of invoices. I love that low-barrier approach. Lucas: Yeah. And if this episode gave you one concrete idea to try, then we've done our job. For Cash Flow Conversations, I'm Lucas. Luna: And I'm Luna. See you next time.