Dynamic Discounting

Dynamic discounting is an early payment arrangement in which a buyer uses its own cash to pay a supplier's approved invoice before the due date, in return for a discount that varies with how early the payment is made. The earlier the supplier is paid, the bigger the discount; on the due date the discount falls to zero. Cash-rich buyers use it to earn a return on surplus liquidity, while suppliers use it as a flexible source of working capital.

It is a modern, data-driven version of the traditional early payment discount, such as "2/10 net 30" in supplier-payment terms, which offers one fixed discount for one fixed early date. Unlike reverse factoring, no bank or outside investor is involved and nothing is sold: the buyer simply pays its own bill early. It usually runs on a supply chain finance platform or an accounts payable portal.

Imagine you owe a friend 100 in a month. Your friend says they need money now, and you happen to have spare cash. You offer: "I will pay you today if you take 98." If they would rather wait two weeks, you might offer 99. The longer they wait, the less you take off, until on the original date they get the full 100.

That is all dynamic discounting is, done at company scale with a computer working out the fair discount for each day. The buyer earns more on its spare cash than a bank deposit would pay, and the supplier gets money when it needs it. Neither side has to borrow from a bank.

Most programmes set an annual rate, often expressed as an APR-style figure, and pro-rate it by the number of days paid early:

Here $D$ is the discount, $F$ the invoice amount, $r$ the annual discount rate set by the buyer, and $t$ the number of days the invoice is paid before its due date. With a 12 percent rate, a 50,000 invoice paid 40 days early carries a discount of 50,000 × 0.12 × 40/365, about 658. The supplier receives about 49,342. If paid 10 days early, the discount drops to about 164.

To compare a fixed early payment discount with other uses of cash, buyers convert it into an annualised return:

where $d$ is the discount as a decimal and $t$ the days gained. Terms of 2/10 net 30 give $d = 0.02$ and $t = 20$, so R = 0.02/0.98 × 365/20, about 37.2 percent a year. This shows why such discounts are attractive for buyers and expensive for suppliers, compared with annual percentage rates on bank loans.

1. The buyer approves supplier invoices in its accounts payable system and publishes them to the portal.
2. The buyer sets the discount rate, sometimes varying it by supplier, size or season.
3. Suppliers see the early payment amount for each date and choose when to be paid, invoice by invoice.
4. The buyer pays on the chosen date through its normal payment run and records the discount as income or a reduction in cost.

Some platforms run auctions, in which suppliers bid the rate they will accept, or let the buyer set a budget for early payments each week. These are variations on the same idea.

Many large buyers run both: dynamic discounting when they have surplus cash, and bank-funded programmes when they want to preserve it. Because it involves no sale of receivables, dynamic discounting does not raise the debt-classification questions that reverse factoring does.

For buyers, the main appeal is yield. Discounts can exceed returns on deposits or treasury bills, and reduce the cost of goods. It can also strengthen supplier relationships and reduce the risk of key suppliers failing. For suppliers, it offers cash without new debt or credit checks, and lowers days sales outstanding.

The limitations follow from the funding source. The programme stops when the buyer needs its cash, so it is less dependable than a bank-funded line. Rates set by a powerful buyer can be high, effectively moving margin from small suppliers to large customers. Treasurers weigh it against their working capital optimization goals and liquidity management policy, since money paid early cannot be used elsewhere. Suppliers should compare the effective rate with alternatives such as factoring before accepting.

• International Chamber of Commerce