Home » What is Discount? Principle | Example | Formula

What is Discount? Principle | Example | Formula

Discount

The discount is a financial reduction granted in the event of cash settlement. In other words, it is the amount deducted from a debtor who pays its debt before maturity.

What is Discount in Accounting

In Accounting, the discount is an exceptional commercial reduction of the selling price granted to the customer for a quality defect of the products of conformity of the order with the predefined characteristics or a delay of delivery.
A discount is granted to billing or after billing.
The billing discount does not appear in accounting. The rebate after invoicing is recorded by an invoice of credit which attests to the claim of the supplier. The discount is a reduction in price as well as rebates (for sales of a certain volume) and discounts forgotten on an invoice.

What is Discount?

A banking discount is used when a company sells a bill of exchange (eg a bill of exchange) to the bank and, in return, the bank makes an advance payment to the company. The purpose of the discount is to limit cash gaps for the company by mobilizing customer receivables.

The Principle of discounting

The discount is for commercial paper. 
Small reminder on the commercial paper: it is a negotiable title that is worth way of payment. The two principal commercial paper which may be brought to the discount are milking (also known as a bill of exchange) and the promissory note.

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Trafficking is the order given by the creditor (the drawer) to its debtor (the drawee) to pay a specified amount to a beneficiary (who may be the drawer himself) on a fixed date (the due date). A draft must correspond to a customer receivable, an actual sale.

In the case of discounting of the slave trade, the beneficiary becomes the bank.

Example of a discount

Company A sells to company B a good worth 1000 $. 
Company A is therefore the creditor and enterprise B is the debtor. 
Company A will give the order to company B to pay it before 45 days. 
Company A sold a good but will only receive the money within 45 days. It may have cash shifts.

The milking discount makes it possible to cope with these discrepancies. Discounting a draft is in fact asking the bank a cash advance corresponding to the amount of the milking, in our case 1000 $. In return, company A will pay a fee. The discount is a short-term credit as to better manage the client.

Cost of a discount line

The cost of discounting a milking
= (milking value x discount rate x number of days) / 36000

In our example, if the bank uses a discount rate of 9%, the discount line will be: (1000 x 9 x 45 days) / 36000 = 11 $ 25

The present value of the milking (the money advanced by the bank) will therefore be: 
1000 – 11.25 = 988 $ 75

Banks add a minimum of 1 banking day to the number of trading days (in our case the calculation would be 46 days) and management fees. The discount rate depends on bank rates and the quality of the debtor.

What is the advantage of discounting?

The discount is an interesting response to cash shifts, and more generally to the management of the client item. The discount is inexpensive and fairly easy to obtain from the banker. The latter will very often prefer to discount the bills of a company than to authorize an overdraft. Indeed, the discount is for him the guarantee of a payment at maturity, while the overdraft is an authorization to be an unsecured debtor that the company will repay creditor.

About the author

Salman Qureshi

Salman Qureshi is an Accountant by profession & he loves to write on Commerce & Management Sciences Subject to assist Students. Hope you guys will like his effort.

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