If you purchase materials during one month, the typical supplier will ask that you pay the bill by the end of the next month. But many suppliers offer an incentive for paying early. For example, my supplier offers a 2% discount if I pay by the tenth of the month instead of by the end of the month. Many large suppliers give discounts of 1% or 2% of the invoice price if the bill is paid by the tenth day of the month following purchase. I receive a 2% discount from my lumber dealer and drywall and plumbing material suppliers.
I look at this discount over the long range. The rate of return of 2% for 20 days (from the 10th to the 30th) would be 3% per month or 36% per year. If the discount rate is just 1%, that translates into 18% per year. Where else can you earn 36% in today's economy?
At our company, we receive $7,000 in purchase discounts every year. I will borrow on my line of credit, based on the prime rate of 4.25%, to take the discount. Usually the reason people don't take advantage is that they don't think it is worth it for $20. But if you do the math, these discounts can add up to big numbers.
I use a flipped version of this discount idea to pay my subcontractors. If my subs send me invoices for work done through the 15th of the month, I pay them on the 30th. For work done by the 30th of the month, I pay them by the 15th of the next month. But many subcontractors ask to be paid early. My policy is to charge them 3% of the actual invoice in order to pay them early. Most subs will submit multiple invoices for each contract as the work progresses. Note that 3% for 15 days is actually an effective rate of return of 6% per month or 72% per year.
--Tom Turnage is a former CPA, current CGR, and president of The Turnage Company in Jacksonville, Fla.
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