The customers who take it are often the ones who paid early anyway.
BY MICHAEL SHANG · SIXTEEN YEARS IN COMMERCIAL BANKING · UPDATED · 6 MIN READ
Offering customers money off for paying early is a way of borrowing, and its real cost depends on how much earlier the cash actually arrives. The headline rate comes from the invoice terms: 2.5% for paying at day 10 rather than day 60 works out at about 19% a year. The true rate comes from customers' habits, because a customer who already paid at day 25 costs far more than one who paid at day 70. A lender looks for the discount in the margin, in debtor days that fell for a reason, and in a borrowing base that shrinks.
BASIS Practitioner judgment from sixteen years in commercial banking, set out in How Bankers Think (Highbank Press, 2026). Every borrower on this site is a composite constructed for teaching, not a client. The market is mid-market commercial lending as practised in New Zealand and Australia; where a convention differs elsewhere, the page says so.
Issue 02 — Aoraki Trade Exports. Paid in USD, costs in NZD, asking for a NZ$6m multi-currency facility. The MD won't say which currencies. Your call first, then the senior banker's.
PART OF Trade Loan
A business that gives up part of an invoice to be paid sooner has swapped a larger sum later for a smaller sum now. That is what a loan does, with the customer as the lender and the discount as the interest. Seen that way, the offer can be compared directly with an overdraft, an invoice finance line or any other source of cash, and that comparison is the first thing a lender makes.
The offer can be sensible. A business that has run out of bank headroom, or wants to reduce its exposure to a shaky customer, may pay more for cash it cannot otherwise get. The offer deserves attention because it is usually introduced as a sales or credit-control measure, and the rate of interest it carries is seldom stated in the board papers.
The discount is divided by what remains after it, because the seller has the use of 97.5 cents and gives up 2.5 to get it. The number of days should be the days the money truly comes forward. Printed terms are a guess at that; the customer's payment record is the evidence.
The accounts then carry it one way or another. Under IFRS 15 and its New Zealand and Australian equivalents, a settlement discount is variable consideration, so revenue is recorded net where the seller expects the customer to take it. FRS 102, which most UK mid-market groups use, adopted a similar five-step revenue model for periods beginning on or after 1 January 2026. Accounts prepared on simpler bases may show the discount as an expense, so when comparing periods a lender checks where it has gone.
A wholesaler of hair and beauty products to salons, constructed for this page like every figure in it, has credit sales of US$48m, 60-day terms, net debt of US$18m and EBITDA of US$6.0m. Its overdraft costs 9%. It offers 2.5% off for payment within 10 days, and 30% of sales take it up. Half of those takers were already prompt, paying at about day 25. The other half were paying at about day 70. Everyone else carries on at about day 68.
The rates are measured on the debtors released, before rounding, which is why the 15% and 61% differ slightly from the formula. The headline said 19%; the offer costs 24%, because half the discount went to customers who needed little persuading. Debtor days improved by 11, which looks like better collection and was purchased. Leverage hardly moved, since the fall in EBITDA ate the fall in debt. The last two lines show the most important result for a borrower on invoice finance: the discount reduces the ledger the financier advances against, so the US$1.48m of cash released repays US$1.18m of funding and leaves US$0.30m once, less than the US$0.36m the discount costs every year. The example treats the whole ledger as eligible and is the page's, not a market norm.
A settlement discount is the seller's fixed offer, printed on its own invoices. Dynamic discounting is the buyer's programme, where the discount varies with how early an approved invoice is paid. Neither is the same as a trade discount or a volume rebate, which change the price for commercial reasons and do not depend on when the cash arrives. Seen from the customer's chair, taking an early settlement discount is a good return on idle cash, and declining one can be a sign of a business short of it.
DEFINED IN ONE PARAGRAPH → · FINANCIAL MANAGEMENT, READ BY A LENDER → · DYNAMIC DISCOUNTING →
A lender looks for three things when debtor days improve. Whether a discount was offered. Whether gross margin fell by a similar amount at about the same time. And which customers accepted it. A customer that newly starts taking a discount tells a different story from one that suddenly stops, because the second may have run short of cash.
The discount often appears when a business is under pressure. If a borrower close to its limit introduces an offer that costs more than its overdraft, the arithmetic suggests that the overdraft has become unavailable, or that the owners think it might. In that case the lender's interest is in the cash flow forecast behind the decision. The discount itself is a symptom. In the example the covenant effect is small. The information is what matters.
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The seats that read this term in an ordinary week. Each page says what the seat is for, who arrives in it, and the shape of the round it runs.
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