KEVOS® MAKEOS · Money
Early Payment Discount Check (Implied Interest Rate, Effective Annual Rate, Take or Pay Net)
A supplier offers a discount for paying early: what annual interest rate does giving it up cost me, and should I take the discount or keep the cash until the due date?
Cost of a supplier’s early payment discount (for example 2/10 net 30): the rate earned per period by paying early, the nominal and effective annual rates over the days gained by waiting (nominal and effective interest, as the interest factors tool), the saving on this invoice, and the decision against your cost of funds.
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How this tool works
Inputs, units and where to find them
| Input | Unit | Typical source |
|---|---|---|
| Invoice amount | AUD | Invoice total the discount applies to (on a GST-inclusive invoice the discount usually reduces the GST too). |
| Discount for paying early | % | Discount offered for early payment. |
| Days allowed to take the discount | days | Days from the invoice date within which the discount can be taken. |
| Days until the net amount is due | days | Days from the invoice date until the full amount is due. |
| Your cost of funds (overdraft or loan rate) | %/year | Interest rate you pay to borrow, or earn on spare cash, per year. |
What each input means
Open an input to see what it is, its units, the worked example and the common mistakes, with a small diagram.
What this means: Invoice amount
- What it is
- The amount on the supplier’s invoice to which the early payment discount applies, used to show the saving in dollars.
- Units and format
- Enter a number in AUD: Australian dollars. The form accepts 0.000001 AUD or more. Required: the tool does not calculate until every input is valid.
- Example
- The form opens with 11000 AUD as a worked example. It is an illustration, not a recommended value: replace it with your own figure.
- Effect on the result
- The saving rises in proportion; the implied interest rate does not change.
- Get it right
- On a GST-inclusive invoice the discount usually reduces the GST as well; check the supplier’s terms.
What this means: Discount for paying early
- What it is
- The percentage the supplier takes off the invoice if it is paid within the discount period, such as 2 in “2/10 net 30”.
- Units and format
- Enter a number in %: percent: the number is read as a percentage, so type 8 for 8 %. The form accepts 0.000001% to 50%. Required: the tool does not calculate until every input is valid.
- Example
- The form opens with 2% as a worked example. It is an illustration, not a recommended value: replace it with your own figure.
- Effect on the result
- A larger discount raises the implied interest rate of paying late steeply.
- Get it right
- Enter the discount as a percentage, 2 for 2 %, not 0.02.
What this means: Days allowed to take the discount
- What it is
- The number of days from the invoice date within which payment earns the discount, such as 10 in “2/10 net 30”.
- Units and format
- Enter a number in days: days. The form accepts 0 days to 365 days. Required: the tool does not calculate until every input is valid.
- Example
- The form opens with 10 days as a worked example. It is an illustration, not a recommended value: replace it with your own figure.
- Effect on the result
- A longer discount window shortens the days gained by waiting, raising the implied rate.
- Get it right
- Count from the invoice date unless the terms say from the end of the month.
What this means: Days until the net amount is due
- What it is
- The number of days from the invoice date until the full amount is due, such as 30 in “2/10 net 30”.
- Units and format
- Enter a number in days: days. The form accepts 0.000001 days to 730 days. Required: the tool does not calculate until every input is valid.
- Example
- The form opens with 30 days as a worked example. It is an illustration, not a recommended value: replace it with your own figure.
- Effect on the result
- A later due date spreads the discount over more days, lowering the implied rate.
- Get it right
- For “30 days end of month” terms, convert to an average number of days from the invoice date.
What this means: Your cost of funds (overdraft or loan rate)
- What it is
- The yearly interest rate you pay to borrow, or earn on spare cash, which the cost of giving up the discount is compared with.
- Units and format
- Enter a number in %/year: %/year. The form accepts 0 %/year to 100 %/year. Required: the tool does not calculate until every input is valid.
- Example
- The form opens with 9 %/year as a worked example. It is an illustration, not a recommended value: replace it with your own figure.
- Effect on the result
- Only moves the take-or-pay-net decision; the implied rate does not change.
- Get it right
- Use the rate on the money you would actually use, such as the overdraft rate.
Method and formulas
- Paying early saves d on a payment of (1 − d), a return r = d ÷ (1 − d) for paying (N − n) days sooner.
- Periods per year m = 365 ÷ (N − n); nominal annual rate = r m; effective annual rate = (1 + r)^m − 1 (nominal and effective interest).
- Take the discount if the effective rate exceeds your cost of funds; saving = invoice × d.
- Example: giving up the discount costs 44.585 % a year (effective); the discount saves A$220.
Limitations
- Assumes you would otherwise pay exactly on the due date; paying late carries its own costs and harms supply.
- A 365-day year and compounding at the payment interval; cash-flow limits, not just rates, may decide.
- Example values are illustrations. Replace them with values for your actual task.
Typical uses
- Decide whether to pay a supplier early for the discount
- Price an early payment discount to offer customers
- Compare trade credit with an overdraft
Who it is for
- Business owners and finance staff
- Purchasing officers
- Engineering managers running budgets
What you get
- Rate per period from paying early
- Nominal and effective annual rates
- Saving on this invoice
- Take the discount or pay net
Interpreting the result
- Short discount windows make even small discounts expensive to forgo: 2 % for paying 20 days early is worth more than 40 % a year.
References
- Machinery’s Handbook, 29th edition (Industrial Press, 2012), printed pp. 134–136. Topic reference; no source tables or recommended settings are reproduced.
Learn the Concepts Behind This Tool
These KEVOS® Library readings explain the method this tool uses, with worked examples.
Method explained here · Library collection
When customers fund the business: deposits, prepayments and what happens when volume falls
In Starting, Funding and Structuring a Business
What it covers: Money collected before delivery is cheap funding, but it is a promise, not profit. How to see what your customer float is made of, limit what it pays for and plan for a fall in orders.
KEVOS® tools are screening and decision-support utilities. Verify important financial, engineering, safety, legal or operational decisions using appropriate professional standards and your organisation’s approved data.