The Power of Purchase Discounts

I was teaching my senior level college finance class a few years ago and really discovered the power of quick pay discounts. I was teaching the class the basic formula outlined in the textbook:


We did a couple problems and moved on.

When we were reviewing the material for the test, someone asked me a question on quick pay discounts, and I explained it differently.

I took basic vendor terms of 2%10, net 30 terms. I went through the math (.02 ÷.98) x (360 ÷ 20) and calculated 36.73% - the cost of not taking the discount.

We discussed the math and simplified saying you figure out how many 20 day periods there are in a year (365/20=18.25) and multiply that by 2% = .365 or 36.5%. I used 365 days in a year vs. the text book’s 360. That’s when it hit me. I can make 2% 18.25 times per year - assuming you pay the vendors exactly at 30 days, in this example.

That’s a lot of extra margin - by paying vendors 30 days instead of 10, I make 36.5%. If I borrow the money at 8%, I still make a net 28+%.

Think about it - what’s your gross margin on your sales?

By using purchase discounts effectively, you can double your gross margin – how’s that for adding profit!