Why the cash discount deserves a closer look
“Payable within 30 days net, 2% discount for payment within 10 days.” This line appears on countless business invoices in Germany, where the early payment discount is called Skonto. Many businesses skip over it or think 2% is small change. That is an expensive mistake. Letting the discount lapse means paying the supplier a price for 20 days of extra time that converts to more than 36% interest per year.
This guide explains what a cash discount is, how to calculate the discount and the payable amount from net or gross figures, what happens to VAT and how to decide whether taking the discount pays off. You can recalculate every example with the cash discount calculator. The article is not tax advice.
What is a cash discount?
A cash discount is a price reduction the seller grants for fast payment. Unlike a trade discount it does not apply immediately, but only under one condition: the customer must pay within a certain period, the discount period. If they pay later, they owe the full amount by the payment term. There is no statutory right to a cash discount. It only exists if it has been agreed, usually in the payment terms on the invoice or in the terms of delivery.
Typical wordings are:
- “2% discount for payment within 10 days, net 30 days”
- “3% discount within 8 days, payment term 60 days”
- “Payable within 14 days less 2% or 30 days without deduction”
Each of these lines gives you three numbers: the discount rate in percent, the discount period in days and the payment term in days. That is all you need for the calculation.
Step 1: Calculate the discount amount
The basic formula is simple percentage arithmetic:
Discount = invoice amount × discount rate / 100
In practice the discount is calculated on the gross amount, i.e. including VAT, because that is the amount the customer transfers. An example: an invoice is for €1,000 net plus 19% VAT, i.e. €1,190 gross. With a 2% discount:
- Discount: €1,190 × 2 / 100 = €23.80
- Amount payable: €1,190 − €23.80 = €1,166.20
Whether you start from net or gross makes no difference to the result. 2% of the net amount is €20.00. The 19% VAT on it is €3.80. Together that is again €23.80. For other percentage calculations the percentage calculator helps.
Step 2: Identify the VAT in the discount
The discount contains a VAT portion. This is not a detail but matters for tax. Under § 10 (1) of the German VAT Act (UStG), the taxable amount is the consideration, i.e. everything the customer spends on the supply, less VAT. If the customer takes a discount, they pay less. The consideration falls and with it the VAT.
You calculate the VAT portion of the gross discount like this:
VAT portion = gross discount × VAT rate / (100 + VAT rate)
In the example that is €23.80 × 19 / 119 = €3.80. At the reduced 7% rate you use 7 / 107. To split any gross amount into net and VAT, use the VAT calculator.
Step 3: Correct output and input VAT
§ 17 (1) UStG governs what happens when the taxable amount changes. The seller must correct the VAT owed (sentence 1). The buyer must correct its input VAT deduction (sentence 2). Both are done for the tax period in which the taxable amount changed (sentence 7). With a cash discount that is the period in which payment was made and the discount taken, not the month of the invoice.
For the example this means:
| Item | Invoice | Discount | After discount |
|---|---|---|---|
| Net | €1,000.00 | −€20.00 | €980.00 |
| VAT 19% | €190.00 | −€3.80 | €186.20 |
| Gross | €1,190.00 | −€23.80 | €1,166.20 |
In the end the seller owes the tax office only €186.20 VAT, and the buyer may deduct only €186.20 input VAT. Forgetting the correction means filing an incorrect VAT return. More on this, including the mandatory invoice detail, in the article Cash discount and VAT.
Step 4: Calculate the effective annual rate
Now for the key question: does it pay to pay early? To answer it, treat skipping the discount as a loan. If you pay after 30 instead of 10 days, the supplier gives you 20 days of credit. The price for that is the discount you forgo. This is known as supplier credit or trade credit.
The effective annual rate of this credit, based on a 360-day banking year, is:
Annual rate = discount rate / (100 − discount rate) × 360 / (payment term − discount period) × 100
For a 2% discount, a 10-day discount period and a 30-day payment term this gives 2 / 98 × 360 / 20 × 100 = 36.73% per year. Why 98 and not 100? Because when paying with the discount you only put up 98% of the amount. The 2% surcharge therefore relates to 98%, not to 100%.
A rule of thumb is often quoted: discount rate × 360 / (payment term − discount period). In the example it gives 36% and is always slightly below the exact value. For a quick decision it is usually good enough. How strongly the rate varies with the terms is shown in the article Supplier credit: the annual rate hidden in a cash discount.
Step 5: Compare with your overdraft rate
An annual rate of 36% is just a number on its own. It becomes meaningful when compared with your alternative. Most businesses would finance an early payment through their business credit line, self-employed people and private individuals through their overdraft. The rule is simple:
- If the effective discount rate is above your overdraft rate, taking the discount pays off, even if you have to overdraw your account.
- If it is below, paying at the due date is cheaper.
You can also show this in euros. Suppose your overdraft rate is 10%. Financing the payable amount of €1,166.20 for 20 days costs €1,166.20 × 10% × 20 / 360 = €6.48. The discount brings €23.80. You are left with an advantage of €17.32.
Long payment terms change the picture. With 2% within 10 days and a 60-day term the annual rate is only 14.69%. With an overdraft rate of 16%, financing for 50 days costs €25.92, which is more than the discount. In that case paying early does not pay off if you have to borrow for it. If you have the money in your account anyway, things look different: then you compare with the interest on savings, which is almost always far below the discount's annual rate.
Step 6: Book it correctly
In the books the discount is only recorded on payment. The buyer first books the invoice in full. On payment, the difference is split between an account for discounts received (net portion) and input VAT (tax portion). The seller books the mirror image to discounts granted and output VAT. The exact entries with examples are in the article Booking a cash discount.
Typical mistakes
- Deducting the discount after the deadline: once the period has expired the buyer owes the full amount. The deduction then has no basis and the remainder stays open. If it is not paid, this can lead to default. The late payment interest calculator computes the interest.
- Not correcting VAT: booking the whole discount as a cost reduction or revenue reduction means too much input VAT has been claimed or too much output VAT paid.
- Discount on items not covered: some terms exclude freight or incidental costs, for example. The wording of the agreement is decisive.
- Getting the start of the period wrong: whether the period runs from the invoice date, receipt of the invoice or delivery is governed by the agreement. More in the article Discount period and payment term.
Checklist
- Read the discount rate, discount period and payment term from the invoice.
- Calculate the discount and the payable amount.
- Work out the effective annual rate and compare it with your overdraft rate.
- Pay in good time so that the payment arrives within the period.
- Book the discount and correct input or output VAT in the month of payment.
Conclusion
The cash discount is one of the simplest levers for better liquidity and a higher margin. For buyers, paying early is almost always a gain, because even an expensive credit line is usually cheaper than supplier credit. For sellers, the discount is an expensive way to get paid faster and should be priced in deliberately. With the cash discount calculator you can see both sides in a few seconds.