Early-Payment Discounts: What 2/10 Net 30 Costs You

You send a $5,000 invoice with net-30 terms, which gives the client 30 days to pay. The client pays on day 29, or on day 41. You can't predict which, and neither can your landlord, who wants rent on the first of the month either way.

An early-payment discount gives the client a reason to pay in the first 10 days. The price is a small cut of the invoice, and for a lot of projects it's the cheapest way to get your money sooner. It costs more than it looks like, though, so the numbers come first.

1.How a 2/10 Net 30 Term Reads

Accountants write the offer as "2/10 net 30." It says the client can subtract 2% from the invoice if they pay within 10 days. Otherwise the full amount is due in 30 days, the same as any net-30 invoice.

On a $5,000 invoice, 2% is $100. A client who pays on day 8 sends $4,900, and you get that money three weeks before the due date.

The discount is optional for the client. You aren't charging a penalty to anyone, so a client who ignores the offer pays the same $5,000 they would have paid before. That keeps the term easy to agree to, because nobody is worse off than the old terms.

Large companies often run on this kind of term. Their payment teams sort invoices by due date and by discount, so a clear offer on your invoice gets it paid first. Small clients like it too, because a 2% saving on $5,000 is $100 they didn't have yesterday.

2.What the Discount Costs You Per Year

A 2% cut sounds tiny. To compare it with other ways of getting cash, turn it into a yearly rate. You give up $100 to get $4,900 twenty days early (day 10 instead of day 30). That's $100 divided by $4,900, or 2.04%, for 20 days. A year has about 18.25 periods of 20 days, so the yearly rate is 2.04% times 18.25, or about 37%.

Few people would knowingly pay 37% a year to borrow money. A 2/10 discount is that same trade, and clients who take it earn that rate for sending money sooner. Here are four common terms on a $5,000 invoice.

Each yearly figure is the discount divided by the cash you receive, multiplied by 365 and divided by the days you gain. Net 60 gives you 50 days of gain, so the same $100 costs far less per year.

3.Pick the Size of the Offer

The right discount depends on what you'd otherwise do about slow payers. Two offers cover most freelance situations.

Option A: 1/10 net 30, for steady clients

A 1% discount costs you $50 on $5,000. Clients who already pay in about three weeks will take it without much thought, and you give up very little. Use it when your late payers are rare and you want most of your invoices to come in sooner.

Option B: 2/10 net 30, for clients who run slow

A 2% discount costs $100 on $5,000. It's big enough that an accounts-payable team (the people who pay a company's bills) will schedule your invoice first. Use it when a client's usual payment takes 45 days or more and the cash matters to you this month.

Skip anything above 2%. At 3% you'd be paying about 56% a year for the money, which costs more than almost any other way you could get cash.

Compare the discount with what the same cash would cost you elsewhere. Say you'd cover a gap by putting expenses on a credit card at 24% a year. Borrowing $4,900 for 20 days at that rate costs about $64 (24% divided by 365, times 20 days, times $4,900). A $100 discount costs more than the card does, so the discount only wins if you have no cheaper option or would pay late fees on your own bills.

Now try a full year. You send ten $5,000 invoices, and four clients take a 2% discount. You give up $400 and collect $19,600 from those four about 20 days sooner. The other six pay the full $30,000 on the usual schedule. Your total is $49,600 instead of $50,000, and that $400 has to buy you something you needed, like rent paid on time or a supplier you no longer wait to pay.

A discount only pays off when the cash you get early is worth more to you than the percentage you give up.

4.Put the Offer on the Invoice and in Your Books

Clients take discounts they can see. Put the terms in three places and write the discounted amount out in dollars.

• The contract or proposal: state the terms once, for example "2% off if paid within 10 days of invoice date."
• The invoice footer: write "Pay $4,900 by November 2 or $5,000 by November 21." Dates beat day counts.
• The payment record: when the client takes the discount, mark the invoice paid at $4,900 and note why the total is short.

For taxes, most freelancers use the cash method, which counts income on the day the money arrives. That makes a discounted invoice $4,900 of income, since $4,900 is what you actually received. If you use the accrual method, you count the full $5,000 when you invoice and record the $100 discount when the client takes it. Check which method your return uses before you pick.

If a client pays $4,900 on day 14, after the window closed, you decide whether to honor it. Honoring it once costs $100. Refusing and asking for the last $100 costs you a conversation, and the client will remember how it went.

5.When a Discount Is the Wrong Tool

Benjamin Franklin wrote in his 1748 "Advice to a Young Tradesman" that "he that is known to pay punctually and exactly to the time he promises, may at any time, and on any occasion, raise all the money his friends can spare." Franklin was talking about people who owe money. The same logic applies to you as the person being owed, because a client with a record of paying on time is worth a discount, and a client without one hasn't earned it yet.

Retainer clients are a poor fit too. A client who pays $2,700 on the first of every month already pays on schedule, so a 2% discount would hand over $54 a month for nothing new.

A discount works on clients who can pay early but don't bother. It does nothing for a client whose cash is stuck, since a company waiting on its own customers can't send money it doesn't have. Offering 2% to a client in that position gives up $100 for no gain.

A late fee solves a different problem. If your clients pay late because they forget, a discount and a fee can sit on the same invoice. The late fee guide covers how to write the fee side of the terms.

If you want to see how much cash a few days faster is worth against your own rates and costs, the free calculator at simplance.org/rate-calculator shows what your numbers look like.