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.
Trade discounts occur when a purchaser buys in bulk, and it is a reduction in cost from the normal retail price on goods. Cash discounts, on the other hand, are generally a reduction in cost if the buyer pays during an agreed upon time. Cash discounts involves payment. Trade discounts involve goods.
With that being said, one advantage of a trade discount is that it will drive up a company's sales volume. When a company sells items in bulk, they may make less profit on each item, but the sales volume will make up for that. Firms offer bulk discounts in order to sell more goods. This can also increase purchase loyalty on the part of the buyer. For example, if the buyer knows that they will receive a 10% discount on the items if they purchase twenty items rather than five, they will be more inclined to buy in bulk.
A second reason firms give trade discounts is to rid themselves of older items that may be sitting on their shelves or in their warehouses. These are typically excess items that have been in their inventory for too long. The longer the goods sit, the more they cost the company. A trade discount is a good tool to move these items. By getting rid of excess stock, inventory can be controlled and managed.