What is Dynamic Discounting?

January 3, 2014 Allison Carpio

what-is-dynamic-discounting

How do you define Dynamic Discounting?

In a nutshell, Dynamic Discounting is the offering of early payment discounts on approved invoices awaiting payment. Gone are the days of only a 2% invoice discount offered if paid in the first 10 days (2/10 net 30). Instead, Dynamic Discounting offers the ability for buyers to choose an APR and offer suppliers discounts calculated on a sliding scale based on the number of days they’re paid early. The earlier buyers pay their invoices, the greater the invoice discount.

How does Dynamic Discounting work?

There are three different dynamic discounting flavors that each work differently: Early Payments, Extended Discount Term and Dynamic Payment Terms aka ASAP terms. Each of these types are opt-in and--with the exception of Dynamic Payment Terms--does not change the PO or supplier’s standard payment terms.

Early Payments

The process starts with the buyer deciding on which suppliers should receive early payments on approved invoices. Through a dynamic discounting software solution, buyers can group suppliers into different Early Payment categories based on geography, supplier size, credit rating, etc. Each category has an established APR as well as liquidity threshold.

Whenever an invoice is approved that belongs to a supplier in this group, and as long as the liquidity threshold is not reached, the invoice is offered to the supplier for an Early Payment. An email notification is sent out, and the suppliers can opt in by choosing an earlier payment date.

After the supplier selects a date, the system calculates the discount percent and amount based on two things: 1) the number of days the supplier selected to be paid early; and 2) the APR the customer set for this group of suppliers.

For example, if the APR is 18%, and the supplier wants to be paid 30 days earlier than his original net due date, the discount would be 1.5% (18% APR / 360 days = 0.05% * 30 days acceleration = 1.5% discount).

Some software solutions offer features that allow the supplier to skip the email notification process, allowing the system to automatically accelerate the approved invoice for payment at the earliest possible date. By automating the process, more money and time is saved.

Extended Discount Terms

Extended Discount Terms are offered on invoices that already offer a procurement negotiated, traditional discount. The buyer then decides what traditionally discounted payment terms should then be extended. Once the invoice is approved, and if the discount cliff is not yet reached, the invoice is offered for earlier payment for an additional discount and after the discount cliff is reached, the invoice is offered for earlier payment for a discount incrementally less dependant on acceleration date.

For example, on a traditional 2% 10, NET 30 invoice, if the invoice is approved on day 2, the standard ERP system normally would wait 8 days to pay the invoice and redeem the 2% discount. With extended discount terms, the supplier can then opt in to be paid any day from day 2 to day 10 for a discount between 2.8% and 2.1%--an additional 0.1% to 0.8%.

After the 10-day discount cliff, the same behavior applies. On day 13, for example, the customer would traditionally wait until the net due date (day 30) to pay the invoice and receive no discount at all. With extended discount terms, if the supplier opts in to be paid early in exchange for a discount, the buyer can receive a discount between 1.7% and 0.1% even after the 10-day discount cliff.

Dynamic Payment Terms (ASAP Terms)

Dynamic Payment Terms are real ERP payment terms with discounts on a sliding scale, similar to Early Payments and Extended Discount Terms.

While Early Payments and Extended Discount Terms are offered on an invoice-by-invoice basis (unless supplier enables an auto-accept feature which allows them to always be paid early, as soon as the invoice in approved), Dynamic Payment Terms (DPTs) are established between the supplier and buyer at the beginning of their contracts. DPTs are maintained like normal payment terms and the term is often entered into the contract, vendor master and the POs. Once agreed on those terms, the supplier no longer needs to opt in, when an invoice is approved, it is automatically paid and the discount calculated on a sliding scale is reflected on that payment.

What are the dynamic discounting benefits to buyers?

Simply put, buyers save money on each invoice paid early!

Holding onto your money for as long as possible is no longer a viable working capital strategy because of the near-zero interest rate environment, and dynamic discounting is a proactive way to generate the highest return possible with no risks associated. In fact, dynamic discounting generates returns more than 50 times greater than Money Market Accounts (MMA) and Treasury Bonds (T-Bonds).

Additionally, buyers strengthen their supplier relationships by providing suppliers with quick, easy access to cash. Most dynamic discounting solutions come with an online portal giving real-time access to financial visibility. This streamlines the communication between buyers and suppliers, reducing inquiry calls and saving Accounts Payable departments time answering these calls.

What are the benefits to suppliers?

Suppliers get paid earlier on approved invoices and have faster, easier access to much needed cash.

Smaller suppliers often have no choice but to finance their receivables or turn to expensive short-term funding options while they wait for payment from buyers. Dynamic discounting is a more favorable financing option in these cases as it takes minimal time investment, is a cheap financing alternative and is money that would come otherwise, just being accelerated. 

Using supplier portals associated with dynamic discounting, suppliers are able to view the real-time invoice and payment status, eliminating the need to call the buyer. Having this information on demand gives suppliers more peace of mind.

Which companies are using Dynamic Discounting?

Fortune 500 companies run these internally managed supplier financing programs. 

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