Cash Discount and Trade Discount

Cash discounts refer to a discount that a seller offers to a buyer in return for paying a bill before the maturity of the due date. In a cash discount, the seller usually reduces the amount that the buyer be indebted by either a small percentage or a particular amount.

A trade discount is a discount in which a manufacturer reduces the listed price of a product when it sells to a reseller, rather than to the final customer. Trade Discount is a reduction of amount from the list price of the goods, which the trader allows to the customer at a given rate.

Cash Discount

A cash discount which is also called a purchase discount or sales discount is a decrease in the purchase price of goods due to early payment of cash. In other words, the seller of goods is aggreging to decrease the price of the goods if the buyer agrees to pay for the goods earlier than the due date. Cash discounts are also called early payment discounts or prompt payment discounts.

In accounting, cash discounts are usually expressed as 2/10, n/30. This format shows the discount amount and the period within which it is available in an abbreviated form.

2/10, n/30 shows a discount of 2% if the buyer pays the amount in the invoice within ten days, otherwise, the net payment is completely due within 30 days.

Advantages of Cash Discount

The advantages of cash discount are as follows:

Reduce or Eliminate Fees:

Cash discounts attract buyers as this reduces or eliminates the fees of credit card processing. Merchant service providers or MSPs charge certain fees to render services or provide credit facilities to their customers which can be reduced in the invoice amounts are paid by availing cash discounts. 

Increase Cash on Hand:

When payment is done in cash by the customers, it gives more access to cash on hand for the business. It is always helpful to have cash on hand as cash is readily marketable and can be easily used for the acquisition of assets or payment to debtors. 

Disadvantages of Cash Discount

The disadvantages of cash discount are:

Avoid Bad Debts:

Allowing cash discounts helps a business to sustain more revenue and thereby more profit. Smart businesses inspect customers before they provide their customers with large lines of credit. However, there are always chances that a buyer will go bankrupt or simply elope. Businesses often have to write off bad debt. Through cash discount, a business may only receive 99 or 98 percent of the face value of the sale price, but it eventually leads to more money for the business overall.

Extra Accounting Legal Work:

It is difficult to predict how many customers will benefit from a sales discount, generally accepted accounting principles require businesses with cash discounts to create an allowance for cash discounts. This allowance account is regulated regularly and reduces the value of net sales. The allowance account also requires time and resources for recruiting employees to maintain and can make basic receivable transactions.

Trade Discount

Trade discount refers to the decrease in list price in the name of discount, allowed by a supplier to the consumer while selling the product usually in greater quantities. Trade discounts are given to the concerned consumer to increase the sales of the business as more customers are attracted when the discount is given on the list price of the product. This discount is usually allowed by the sellers to attract more customers and receive the order in bulk, which is to increase the number of sales. Also, no record is to be maintained in the books of accounts of both the buyer and seller.

Advantages of Trade Discount

The advantages of trade discounts are:

Increased Sales:

A trade discount is an easier and most common method to attract a customer’s attention, by providing more for less. Promotional sales, coupons, volume purchases, and other strategies can attract new customers and encourage them to purchase the products, creating the impact that they are getting the optimum out of their money. Offering a reduced price for multiple purchases will increase the possibility that customers will want to purchase more to take advantage of the opportunity from the company.

Improve Your Reputation:

Offering trade discounts is also an excellent way to enhance the customer’s thoughts about the company. If customers believe that the company is offering good value for money, they will probably like to put their trust in the goods and services of the company. This provides the key to building a healthy relationship between the customer and the supplier for customer satisfaction and retention.

Disadvantages of Trade Discount

The disadvantages of trade discounts are:

Lost Revenues:

The most common disadvantage of offering trade discounts is the cost of lost revenues associated with the bottom line profits. The cost of trade discounts must be compared against the improved cash flow expected. Allowing trade discounts to the customers reduces the margin of the profit that could be achieved without providing trade discounts to the customers.

Time Consuming:

Another common disadvantage of trade discounts is the increase in the time required for billing and processing of accounts receivable. To take complete advantage of trade discounts, billing should be done as early as possible, which is usually on the shipping date. For some small businesses, additional clerical staff may be required for this process.

Differences between Cash Discounts and Trade Discounts

The differences between cash discounts and trade discounts are discussed below:

Based on Aim: Cash discounts are more like a negotiation process that initiates the buyer to make payments before the due date. Trade discounts are more like a way to retain business by initiating the buyer to buy products in bulk quantities and become a regular customers.

Based on Source: A cash discount is given by the seller to the buyer when the buyer is making a purchase transaction. It is not known in advance but decided more on an instant basis. A trade discount is given by the seller to the buyer when the buyer is buying goods as per the discount policy of the seller.

Based on Accounting: Cash discounts are recorded on the debit side of the cash book. Trade discounts are not recorded in the books as the net amount payable is calculated after reducing the discounted amount from the invoice.

Based on Significance: A cash discount is given when the buyer initiates payment before the due date. A trade discount is given by the seller as a decrease in the listed price of the product.

Based on Timing: A cash discount is implemented when the buyer initiates payment. A trade discount is implemented when a buyer is initiating an order for purchase.

Conclusion

In this article, we have learned the meaning of accounting terms cash discount and trade discount. Cash discounts refer to a discount that a seller offers to a buyer in return for paying a bill before the maturity of the due date. Trade Discount is a reduction of amount from the list price of the goods, which the trader allows to the customer at a given rate.

A cash discount is given by the seller to the buyer when the buyer is making a purchase transaction. It is not known in advance but decided more on an instant basis. Cash discounts are recorded on the debit side of the cash book. 

Trade discounts are not recorded in the books as the net amount payable is calculated after reducing the discounted amount from the invoice. A trade discount is given by the seller to the buyer when the buyer is buying goods as per the discount policy of the seller.