Value of the Discount = Discount % x Invoice Amount
Example 2% Discount x $5,670 Invoice = $113.40
Borrowing Costs =
((Annual Interest Rate on Loan x Invoice Amount less Discount)/365) x Days
Example ((12% Interest Rate x $5,556.60 Invoice less discount)/365) x 20 days = $36.54
Net Effect Discount of $113.40 - Borrowing costs of $36.54 = Gain (savings) of $76.86
(Note 1: Days is equal to the difference between the end of the discount period and the end of the net period.)
(Note 2: You only borrow an amount equal to the discounted value of the invoice)
Unless the interest rate on your borrowing is excessively high, you will save money borrowing to take the discount.
In fact, the annual interest rate on your borrowings in the example above could exceed 35%, and you would still be better off borrowing the money to take the discount. (Substitute 35% for the 12% in the example above and recompute)
Assume interest rate on savings account = 1.5% annually
Opportunity Costs =
((Annual Interest Rate Paid On Savings x Invoice Amount less Discount)/365) x Days
Example ((1.5% Annual interest rate x $5,556.60)/365) x 20 = $4.57
Net Effect Discount of $113.40 - Opportunity costs (Interest lost) of $4.57 = Gain of $108.83
(Note 1: Days is equal to the difference between the end of the discount period and the end of the net period.)
(Note 2: You only take from savings an amount equal to the discounted value of the invoice)
To get a real feel for the impact that supplier discounts can have on your profits, do the following calculation.
Assume that:
The savings available on an individual house would be $300,000 x 40% x 2% = $2,400.00.
If you saved that much for the 20 houses you build in a year, the savings would amount to $48,000, which can contribute to the wages for a site supervisor or an office manager.
More than enough to pay attention to.