There are following benefits or advantages of offering cash discounts in business:
(1) Discount offer induce a trade receivable to pay early, which not only avoids the chances of future bad debts but also reduces the expenses of collecting outstanding debts and financing costs on tied up capital in trade receivables.
(2) The early payments from customers improve liquidity position of the business.
(3) Discounts may increase sales volume as the sales prices appear cheaper than competitors.
Why Provisions are made for Bad Debts and Discounts Allowed?
(1) The estimated losses on account of likely bad debts and discounts allowed are charged to the period in which revenue or income is earned (current year) instead of the actual occurrence period (may be the following year).
(2) “Prudence” concept requires that all expected losses including doubtful debts and discounts allowed are accounted for as soon as they are likely to arise in future.
(3) Trade receivables are shown at true net realizable value when both provisions are deducted from them in the balance sheet. This is also in accordance with “Prudence” concept.