Trade Discount

Trade discounts are of the most common accounting terms. It is handed out often, to encourage sales. There are ways you can calculate a fixed discount rate so that you do not incur losses.

Reasons for Giving Trade Discount

A company produces goods and services with the point of view for selling them. The always optimistic idea of the company here is that if they produce more, they can sell more and in turn earn more in the form of sales revenues. By producing a lot more, they can avail the benefits of economies of scale as well. This means that the more standard produce you make, the more your cost of production per unit decreases.

But this mentality often leads to overproduction. Too often producers overestimate the demand, which leads to a lot of stock lying unsold and which the buyers may not be tempted enough to buy at the present prices. The other concern from the point of view of the seller is to recover money. Suppose the seller has his supplier to pay off soon and doesn't have the cash in hand to pay his creditor, he might be in a spot to be bothered. All businessmen know this and hence several operate with the 'cash sales only' model so that the problem of a lack of liquidity will not impede their operations.

Others, in a cash crunch due to both the above reasons - overproduction and too many credit transactions, may choose to fire-sell a lot of their goods at any price they can get for it.

Calculating Trade Discount

It's what the seller offers his goods at a reduced price in order to tempt someone to buy. It thus is a discount which facilitates trade. A trade discount is generally given to a buyer who offers to purchase the goods in bulk, generally, towards the end of the season. In case of seasonal goods, the seller would not want to have a large stock lying unsold and which will remain unsold, for a large part of the year. Hence the seller may have to offer a drastic cut in the price, if he is to tempt a prospective buyer into buying his goods.

The arrangement is also used to tempt the buyer into buying a larger quantity of goods than he originally needs as the dangling carrot of economy of large-scale buying is too tempting to resist for most businessmen!

The trade discount is widely feted to be an arrangement which benefits both the seller and the buyer. The buyer in this case can get the goods he needs at a remarkably low price quite similar to discount shopping so to speak - and the seller can get rid of the goods lying unsold in the warehouse, which would otherwise fetch nothing, for a good price which in turn improves his liquidity position.

The formula is a simple one and makes it all the more easy to sell the goods!

Selling Price = Marked Price (1 - Discount %/100)

So if you want to sell something worth USD 500 at 25% discount.

Selling Price = $500 (1 - 0.25)
Selling price = USD 500 (0.75) = USD 375

With the help of the trade discount, you can really increase the sales of your products!