Sign up to receive accounting tips, videos, news and webinar info before anyone else
Mailing Address
21750 Hardy Oak Blvd
Ste 104 PMB 63328
San Antonio, TX 78258-4946
(760) 697-1033
When we’re thinking about cash, we have to think about the discounts that we might be offering, and how discounting affects profitability. Clearly, we want to try to take discounts if we get them. But what about discounts that we’re offering, sales or incentive discounts for people to either buy more, do different things with our products, or buy them at certain times? What about sales discounts? What is that doing to the cash and profitability of our business?
Understanding the Relationship Between Discount and Profit
Understanding the relationship between discount and profit is essential for any business owner. Sales discount accounting is a crucial aspect of this understanding, as it helps to determine how discounts affect profit margins.
Discounting in accounting involves reducing the selling price of a product or service to encourage customer purchases, but it can impact the overall profitability of a business. The discount in accounting can be recorded as a reduction in revenue, which can decrease the net profit margin.
However, discounts can also increase sales volume, leading to higher overall profits. It is important to consider the impact of discounts on both revenue and profit to make informed business decisions.
DO SALES DISCOUNTS REDUCE NET REVENUE?
Yes. In terms of how discounts affect profit, when a business offers a discount, it decreases their profit margin and lowers the total net revenue they can earn from each sale.
HOW DOES OFFERING DISCOUNTS AFFECT PROFITS?
Offering discounts can have both positive and negative impacts on a company’s profits. On one hand, discounts can attract customers and increase sales volume, leading to higher revenue.
On the other hand, discounts can also reduce profit margins, as the discounted price reduces the overall revenue per sale. Accounting for sales discounts is crucial for businesses to make informed decisions about pricing and promotions.
To evaluate the impact of offering discounts on profitability, businesses should consider factors such as the cost of goods sold, marketing and promotion expenses, and the impact on customer loyalty and repeat business.
A comprehensive profitability plan that considers these factors can help businesses optimize their pricing and promotions strategies and ensure sustainable profitability.
LONG-TERM VS SHORT-TERM IMPACTS OF DISCOUNTING ON PROFITABILITY
Understanding the Balance
How does offering discounts affect profits in the short term and the long term? While discounts can boost immediate sales and cash flow, they may also have unintended consequences on a company’s brand value and customer expectations over time. Let’s compare the discount impact of business revenue in the short term and the long term.
Short-Term Benefits
In the short term, discounts can be a powerful tool. They can significantly increase sales volume, improve cash flow, and attract new customers, especially in competitive markets. Short-term discounts are particularly effective for specific goals like clearing excess inventory, launching new products, or achieving sales targets within a tight timeframe.
Long-Term Considerations
However, the long-term impacts of discounting require careful consideration. Frequent or deep discounts can lead to a perceived devaluation of the brand. Customers might begin to associate the brand with lower quality or only wait to purchase when there’s a sale, affecting regular sales at standard prices. Frequent discounting can create a cycle where customers are reluctant to purchase at full price, impacting the overall profitability and positioning of the brand in the market.
DISCOUNTS FOR SALES
Discounts are one of the easiest ways to sell. If I’m a salesperson, the easiest thing that I can do is lower the price of services. Remember the 4 P’s of marketing: price, product, place, and promotion. If we just sit there and take the decreased price, that’s a marketing effort, but sometimes it’s going to ruin your profitability. Let me show you how destructive it can actually be.
HOW TO CALCULATE PROFIT MARGIN AFTER DISCOUNT
If we take a simple business and we’ve got revenue, COGS (cost of goods sold), gross profit, SG&A, and NOI (net operating income) and say revenue is 100. A typical manufacturing business that we’re talking about here – let’s say they’ve got 70 in their cost of goods sold, which means their gross profit is now 30. And in their SG&A, they’ve got roughly 20, which means their net operating income is now 10. Very simple manufacturing business.
But what if we offer a 5% discount to our customers because they’re buying in bulk? 5% sounds like it’s not a big deal. But let’s take a look. What’s our new cost of goods sold? It hasn’t changed. We’re still at the same cost of goods. So what’s our new gross profit, however? Now it’s only 25. What’s our SG&A? That hasn’t changed, that’s still at 20. We’re now at 5 in terms of profitability. That is a 50% decrease%. A 50% decrease simply because you offered a 5% discount. It’s incredibly important to understand, when you’re doing pricing, how to alleviate this issue.
BUILDING A PRICING STRATEGY THAT WORKS
A lot of industries out there have to take discounts. We have to take things like credit cards, because credit cards are going to do the same thing. Maybe it’s not 5%, maybe it’s 2.5%, but it still has a destructive impact on the bottom line. How do we adjust for that? Well, we have to understand that this is part of our business model, and instead maybe we take our price from 100 to 106. Now, we give our sales people the opportunity to offer up to a 5% discount. They’re not always going to do it, but when they do, we’re still at the same levels. The difference is, now we’re plus 10% in our profitability.
Now it’s not simply that easy, but you’re always going to be thinking about playing this game and as long as you know the numbers, you’re going to be able to price and discount effectively without running yourself out of business.
Alternatives to Offering Discounts
While offering discounts can be an effective way to increase sales volume, understanding how discounts affect profit may encourage you to consider alternatives that can be more productive and profitable for a business in the long run.
One option is to focus on adding value to products or services, rather than simply lowering prices. This can be achieved through features such as better quality, faster delivery, or improved customer service.
Another alternative is to offer bundled packages or cross-selling options that encourage customers to purchase additional products or services. These strategies can help to maintain profit margins while still incentivizing customers to make a purchase.
Additionally, businesses can focus on increasing brand awareness and loyalty through targeted marketing and advertising campaigns, which can lead to more sustainable and long-term growth.
The Role of Accounting and Financial Experts: Discounting Strategies
With all of these factors to consider, your business might benefit from the guidance of a financial expert. These professionals can help you understand how discounts affect profit in your specific industry. They can align discount strategies with your business’s overall financial health and long-term objectives.
Rather than one-size-fits-all strategies, hiring a financial expert means you get tailor-made strategies for your business’s unique needs. From understanding how discounts affect profit to monitoring the performance of a new strategy, you’ll be better positioned to thrive.
At TGG, we pride ourselves on offering expert financial guidance. Our team is dedicated to helping you navigate discounting strategies effectively, setting up your business for optimal growth and profitability.
How TGG Can Help
Our accounting and financial experts are committed to helping you strategize and evolve your business model to reach high levels of success. If you’re wondering whether or not discounting your products will yield the desired results, TGG experts are here to evaluate your business plan and help you divulge the best plan of action. Get in touch with us today to learn more!
Read More >>>
Matt Garrett is the Founder and Chief Executive Officer of TGG. He is a regular speaker across the country on behalf of Vistage educating business owners on the need for sound financial practices, and is Vice President of the Board of Directors of FINACA. Under Matt’s leadership, TGG has received the following recognition: INC. 5000 top companies in the U.S. five years in a row; one of “San Diego’s Fastest Growing Companies” the past four years; and is among San Diego’s “Best Places to Work.”
