What are two reasons firms offer trade discounts?
A trade discount is offered in a business setting and facilitates a reduction in the cost of goods and services purchased by a company. Trade discounts are typically offered within a specified timeframe, for example, two weeks or six months depending on the size of the outstanding balance. If this timeframe passes without payment, the company is expected to pay the undiscounted, outstanding balance.
One of the main reasons why firms offer trade discounts is to encourage debtors to clear their outstanding balances quickly. When debtors owe sums for extended periods of time, the likelihood of bad debts (debt that is uncollectible) increases significantly. Therefore, creditors incentivize debtors with trade discounts in order to ensure debtors pay off their outstanding balances quickly after receiving the goods and services.
Another reason why firms offer trade discounts is to foster brand loyalty. Trade discounts increase the purchasing power of the debtor—that is, the debtor is able to pay for other expenses with the money saved from the receipt of a discount. Other suppliers in the industry, however, may not offer this incentive to their customers. Therefore, a company may choose to buy only from one particular supplier because that supplier offers trade discounts. Subsequently, by offering trade discounts, a supplier reduces the probability of losing its customers to the competition.