In business, the relationship between a seller and a buyer is quite unique - both try to sell/avail a product at a price that they are comfortable with.
The seller often tries to promote sales by offering incentives, festive offers ordiscounts. On the other hand, wholesale or retail buyers expect some form of incentive when they purchase any product in bulk. Let’s understand the concept of discount in detail and the difference between trade discount and cash discount.
What is a Discount?
Discount refers to theprice reduction madefrom the gross amount or value of something. By reducing the selling price, most sellers try to push the sales of their products. In the world of transactions, offering a discount is a way to build brand loyalty by offering something of value to the consumer.
Offering discount deals for special occasions and festivities is a great way for businesses to gain new customers and reward existing ones.
What are the Two Main Types of Discounts?
In business, there are primarily two types of discounts:
- Trade Discount: Reduction in the listed price of a product that a supplier offers when selling to a reseller in bulk.
- Cash Discount: Reduction in selling price that the seller offers to the end-consumer for prompt, faster sales.
What is a Trade Discount?
Trade discount is a type ofdiscount (reduction in the list price)offered to a wholesaler, retailer or reseller forpurchasing a product in bulk. This type of discount is mainly offered to increase the sales of the business and encourage bulk orders.
It should be noted that a trade discount does not affect an organisation’s profit margin as it is not recorded in the account books.
Why are Trade Discounts Offered?
Businesses often have product catalogues for wholesalers, resellers and retailers. The good news is that the prices of the products listed in the catalogues are not final. This is because when resellers decide to buy the product in bulk, the manufacturing business may decide to offer a discount on the listed price to initiate the trade. Hence, it is called a trade discount.
Offering atrade discount to a customer is away of modifying the product’s selling price for that particular customer. This is primarilyoffered to promote business-to-business(B2B) sales and maintain a good buyer-seller relationship.
How are Trade Discounts Calculated?
The trade discount is deducted from the seller’s original catalogue price either as a percentage discount or a flat monetary amount.
Theformula to calculate trade discount is as follows:
Discount Type | Trade Discount | Selling Price (SP) after Discount |
Specific amount | The amount decided by the seller | List Price - Discount amount |
Percentage | Trade Discount Amount = Discount % X List price of the product | Listed price X (1 - Trade discount %) |
Example of Trade Discounts
Let’s say the catalogue price of handmade soap is Rs.1,000, and the seller is willing to offer a trade discount of 10% only if the buyer purchases a package of 100 soaps at once.
Total purchase amount = Rs.1,000 x 100 = Rs.1,00,000
Then, the discount amount offered is:
Trade Discount = Rs.1,00,00 × 0.10 = Rs.10,000
This means the buyer would receive a discount of Rs.10,000 on the order, resulting in a final price of Rs.90,000 (Rs.1,00,000 – Rs.10,000). In this case, the price of each soap would come down to Rs.900.
It’s important to note that the trade discount has to be applied before any other calculations.
What is Cash Discount?
Acash discount, also known as asales discount, is adecrease in the purchase price of goods to encourage early payment of cash. Many businesses and distributors offer a certain percentage of price reduction in the invoice amount. It is like an incentive offered to the buyer in exchange for early or immediate cash payment.
Why are Cash Discounts Offered?
Businesses offercash discounts to prompt quick sales andreceive immediate payments. After receiving this incentive, the customer may decide to pay for everything in full within a shorter period of time than what was previously agreed upon. This is why businesses offer this discount to improve sales and bring more income.
Another reason why some businesses offer acash discount is that they want toavoid the chargesassociated withcredit card transactions. To do this, businesses offer a cash discount in exchange for a cash payment from the customer. This removes the hassle of paying credit card processing fees for transactions.
How are Cash Discounts Calculated?
Thecash discount can be calculated using the following formula:
Cash Discount = Purchase Price x Rate of Discount
You need to subtract the cash discount from the original purchase price to know the final selling price.
Thefinal price offered by the seller =Original purchase price - Cash Discount
As discussed above, cash discounts are typically offered to speed up the payment and boost sales.
Example of Cash Discounts
Let’s understand how cash discounts work with the help of an example:
Let’s say that the regular purchase price of a product is Rs.3000. The seller wishes to offer a cash discount of 15% on the product. Thus, the new price has to be calculated after subtracting the discount amount.
By using the formula mentioned above,
Cash Discount = Rs.3000 X 15% = Rs.450
Therefore,
The final purchase price offered = Rs.3000 - Rs.450 = Rs.2550
It should be noted that this type of discount is only offered when the buyer decides to pay the amount in cash. This is a popular method to settle outstanding due bills and promote quick payments.
Key Differences between Trade Discount and Cash Discount
The primary differences between trade discounts and cash discounts have been explained below:
Trade Discount | Cash Discount |
Offered by sellers to resellers when he/she is purchasing a product using the discount policy. | Offered by sellers to buyers when he/she is making a purchase transaction. Hence, it can be decided on an ad-hoc basis. |
This discount strategy is primarily used to retain customers and make them future buyers. | This is more like a negotiation tactic to ensure upfront or immediate payments. |
Since the amount payable is calculated after reducing the trade discount from the bill, this discount is not recorded in accounting books. | A cash discount is recorded on the debit side of the cash book. |
It is a quantity-specific transaction that is executed when a buyer is initiating a buy order. | It is a cost-focused transaction that is executed when a buyer is initiating payment. |
Allowed on both cash and credit transactions. | Allowed only for cash transactions. |
Conclusion
Trade and cash discounts are essential elements of business transactions between suppliers, resellers and buyers. Although their end goal is the same - to sell products - the discounts differ in terms of timing and mechanism. Selling and buyers can ensure a smooth transaction by implementing these discount strategies.
Related Articles:
1. Difference Between Void and Voidable Contract
2. Difference Between Money Market and Capital Market
