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What is a Cash Discount?
Cash discounts are incentives offered to buyers that reduce the amount owed to the seller by either a fixed amount or a percentage of the total bill. If an invoice fx is due in 30 days, a seller could offer the buyer a cash discount of say 2% if the invoice is paid within the first 10 days of receipt.
Small cash discounts like this benefit the seller because they increase the chance that a buyer will pay quickly, thus providing the seller with cash faster. Having cash sooner rather than later allows the seller to put the cash back into the business faster – a good motive for any company.
Cash discounts vs. trade discounts
Cash discounts are not reductions in the set sales price of a good or service at the time of the transaction – they are a reduction in the amount to be paid by a credit customer (one that is not paying in cash) if that customer pays their debt within a specified time period.
Cash discounts are offered in order to persuade credit customers to pay their bills faster – they are not meant as an incentive to make the purchase in the first place.
Cash discounts in accounting are usually expressed in the format 2/10, n/30. This shows the discount amount and the time period within which it is available in shorthand form.
2/10, n/30 indicates a 2% discount if the buyer pays the invoice within ten days, otherwise the net payment is fully due within 30 days.
How to record cash discounts in accounting
There are two different methods for recording cash discounts in your accounting journals: the gross method and the net method.
In the gross method, discounts that aren’t taken by the buyer (e.g. when the buyer does not pay within the discount period) are simply treated as a portion of total sales revenue. The gross method is most commonly used method in business practice today.
In the net method however, sales revenue is treated as the net amount after the given discount, and any discounts that the buyer doesn’t take are recorded as interest revenue. This means that discounts are essentially treated as compensation to the seller for providing credit to the buyer.
Whichever recording method is used, anytime a cash discount is taken by a buyer, this will reduce the seller's sales revenue.
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