Definition: A cash discount is an incentive offered by a seller to a buyer for paying an invoice ahead of the scheduled due date.
Cash discounts are incentives offered by sellers that reduce the amount that the buyer owes by either a percentage of the total bill or a fixed amount. For example, if an
invoice is due in 30 days, a seller could offer the buyer a typical cash discount of 2% if they were to pay the invoice 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, therefore providing the seller with
cash more quickly. Having cash sooner rather than later means that the seller can in turn put the cash back into the business sooner rather than later – a good motive for any organization.
Cash discounts vs. trade discounts
Cash discounts are not reductions in the agreed
sales price of the goods or services at the time of the transaction – they are a reduction in the amount to be paid by a
credit customer (one that you have give credit terms to ) if that customer pays their debt within a specified time period.
A cash discount is intended to persuade credit customers to pay their bills quickly – not an incentive to make the original purchase.
Cash discounts: shorthand
In accounting, usually the discount amount and the time period within which it is available are expressed in a format such as 2/10, n/30. This means a 2% discount if the invoice is paid within ten days, otherwise the payment is due in its entirety within 30 days.
Recording cash discounts: net vs. gross method
In accounting, there are two different ways that you can record cash discounts in the journals: the net method and the gross method. The net method treats sales revenue as the net amount after the given discount, and any discounts that the buyer doesn’t take are recorded as interest revenue.
Therefore the discounts are essentially treated as compensation to the seller for providing credit to the buyer. On the other hand, the gross method simply views discounts that aren’t taken by the buyer as a portion of total sales revenue – not as separate interest earnings. The gross method is most commonly used method in business practice today.
No matter which recording method is used, a cash discount taken by a buyer will reduce sales revenue.