What it means
The three numbers are read in order. The first is the discount percentage, the second is the number of days in which the discount is available, and the third is the number of days by which the full invoice must be paid, counted from the invoice date.
Suppliers offer these terms to speed up their cash collection. Money received 20 days earlier can reduce borrowing, cut the risk of non-payment and improve the supplier's working capital (the cash tied up in day-to-day trading).
A 1% discount sounds small, but it is earned for paying only 20 days early. Annualised, the effective return is far higher than most banks pay on savings or charge on short-term loans, which is why many finance teams take the discount whenever they have the cash.
The calculation of the true cost of skipping the discount is therefore a standard working capital exercise. If the buyer pays on day 30 instead of day 10, it is effectively borrowing from the supplier for 20 days at an implied interest rate.
There are other variants of the same pattern, such as 2/10 net 30 or 2/10 net 45. The basic logic is the same, though a larger discount or a shorter window changes the implied rate, and the invoice must state the exact terms.
Buyers should still compare the discount with their own cost of funds and with the effect on their cash balance. A business that is short of cash may rightly decide that paying early is not worth it, but it should make that choice knowingly.
In practice
Real-world examples.
Example
A restaurant group buys $80,000 of ingredients each month from a wholesaler offering 1/10 net 30. The finance manager pays each invoice on day 10, saving $800 a month, or $9,600 a year. She funds this from a credit line that costs far less than the implied rate.
Example
A marketing agency receives a $12,000 invoice from a printing supplier on 1/10 net 30 terms but has cash tied up until a large client pays. The owner decides to wait until day 30 and forgo the $120 discount. She makes a note that the decision is costing her the equivalent of a high-interest loan.
Example
A building materials manufacturer offers 1/10 net 30 to its trade customers to improve its cash position. Within a year, about half of customers pay early, and the average collection time falls from 45 days to 30 days. The finance director tracks the discount cost against the lower borrowing bill.
Formula
Calculation
Annualised cost of skipping the discount = (Discount % / (100% - Discount %)) x (365 / (Full payment days - Discount days))
Suppose a $50,000 invoice carries 1/10 net 30 terms. Paying on day 10 means paying 50,000 - 500 = $49,500, so the discount is $500. The cost of waiting 20 extra days is 1 / 99 = 1.0101% of the amount paid. The number of 20-day periods in a year is 365 / 20 = 18.25. Annualised cost = 1.0101% x 18.25 = about 18.4%, so a buyer who can borrow at less than that rate should take the discount.Case study
Seen in the real world.
Larkspur Electronics is an illustrative, fictional distributor that buys $1,200,000 of components a year from one supplier on 1/10 net 30 terms. For years the accounts payable team paid on day 30 to hold on to cash, without testing whether that was sensible.
A new finance manager calculated that the forgone discounts cost $12,000 a year, an implied annual rate of about 18.4%. The company's overdraft cost only 9%, so paying early and borrowing to fund it would clearly save money.
She moved payments to day 10 and funded the 20 days of extra cash needs, an average of about 1,200,000 x 20 / 365 = $66,000, from the overdraft at a cost of roughly $5,900 a year. After keeping the $12,000 discount, the illustrative saving was about $6,100 a year, a modest but low-risk improvement, and a good example of why payment terms deserve regular review.
Watch out
Common mistakes.
- Ignoring the discount because 1% looks too small to matter, when the implied annual rate is usually much higher than the cost of borrowing.
- Counting the 10 days from the date the invoice is received, when the terms usually run from the invoice date and the exact rule should be checked.
- Taking the discount on a late payment, which suppliers may reject and which can damage the trading relationship.
Questions
People also ask.
Does 1/10 net 30 mean the invoice is due in 10 days?
No, the full amount is due in 30 days, and the 10-day mark is only the deadline for earning the 1% discount.
How do I record an early payment discount in the accounts?
Most businesses treat it as a reduction in the cost of the purchase or as financing income, depending on the accounting policy they follow.
Is it better to take the discount or keep the cash?
Compare the annualised rate of the discount with your cost of borrowing or the return on the cash, and take the discount whenever its rate is higher.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%