Description: Few accounting activities can be shown to directly save money – taking early payment discounts is one of them. From the accounting perspective, this means examining incoming invoices from suppliers to see if a discount is offered, determining if the discount is economical, and scheduling it for early payment. By comparing the proportion of purchase discounts taken to total discounts available, one can see how effective the accounts payable staff has been at saving money for the company. Any measurement result less than 100% should be considered unacceptable.
Formula: Divide total purchase discounts taken by the total amount of economical discounts available. The information needed for the numerator is generally simple to collect, because a typical accounting system will store the amount of the discount in a separate line item in the chart of accounts. The problem is in deriving the information needed for the denominator, since this information is not stored anywhere. One can query the supplier database in an automated accounting system to see which suppliers are listed as having discounts, but this will ignore any suppliers for whom the accounts payable staff has missed the presence of discounts on their invoices. Consequently, a better approach is to supplement the review of the existing accounts payable database with an ongoing audit sample of supplier invoices, to see what other invoiced discounts have been missed.
Also, all offered discounts with terms so poor that they should not be taken should be excluded from the denominator (since they are not viable discounts). The formula is as follows:
Total Purchase Discounts Taken
Total Economical Discounts Available
Cautions: The results of this measurement can be misleading when invoices are sent back outside of the accounting department for approvals, since a delayed approval can take longer than the required payment date on a discount. The same problem arises for centralized accounts payable departments that service many company locations, because invoices may be sent to outlying locations by suppliers, which builds in a time delay while those locations send the invoices to the central accounts payable location. If the approvals problem is evident, one can restructure the accounts payable function so that all invoices are logged into the system for payment before they are sent back out for approvals, so that they can be paid on the required date without having to wait for an overdue approval. If delays are caused by a centralized accounts payable system, then the accounting staff can contact suppliers to have them change their “bill to” addresses to match that of the accounts payable center.