Prompt pay discounts

A key component of profitability is collecting revenue as quickly as possible. Often, healthcare entrepreneurs offer a "prompt pay discount" to patient-customers who are willing to pay on or near the date of service. Let's take a dive into the economic influence that patient-customers experience if they forgo the prompt pay discount.

What is a prompt pay discount?

Aa healthcare entrepreneur who provides a good/service to a patient-customer is, in essence, offering a loan. The value of the loan equals the bill that the entrepreneur charges to the patient-customer. Like all loans, there is a cost for that capital: the interest rate. The cost of the loan that a healthcare entrepreneur charges to the patient-customer is reflected in the prompt pay discount. Thus, we can view the interaction between entrepreneur and patient-customer as:

• loan = bill charged to the patient-customer

• interest rate = prompt pay discount

Why offer a prompt pay discount?

The answer is simple: having cash today favors profitability over the possibility of more cash tomorrow. The certainty of less cash at t = 0 is better for a healthcare entrepreneur than the uncertainty of more cash at t > 0.

(0% < cash ≦ 99%)x(cash at t = 0) > (100%)x(cash at t > 0)

Why would a patient-customer not accept a prompt pay discount?

If a patient-customer does not have the cash to pay the discounted price, s/he won't pay at the time of service ( t = 0). What happens next, specifically when the patient will pay, depends on the interest rate of the loan (i.e., the prompt pay discount) and the prevailing interest rates in the market place.

A prompt pay discount of 1%

If a patient-customer does not take advantage of a prompt pay discount, s/he is assuming a loan (i.e., the value of the service s/he just received) at an interest rate of 1%. The interest rate is simple (it is not compounded) and can be annualized so that it can be compared to the prevailing annual interest rate in the marketplace (learn more about simple vs. compound interest here).

The annualized interest rate that the patient accepts as the true cost of the loan will depend on when the patient finally pays your bill. For example, if the patient pays 10 days later (t = 10), the patient will assume an annualized simple interest rate of 36.5%. How did we come to that calculation?

If a patient-customer pays at t = 10 days, then s/he is assuming a 1% simple interest every 10 days. In a year (365 days), there are 36.5 periods of 10 days. Each period costs the patient-customer 1%, so the annual simple interest rate that s/he accepts is 1% x 36.5 = 36.5%.

If the same patient-customer pays at t = 20 days, the annualized simple interest rate that s/he would accept as a cost of the loan is 18.3%. 

When will the patient-customer pay if they sacrifice the prompt pay discount?

As long as the annualized simple interest rate is greater than the prevailing interest rate, the patient-customer has an economic incentive to not pay the healthcare entrepreneur. Why? If the prevailing interest rate is 5%, then the patient-customer would be incentived to pay his/her bill after 2 months of arrears (60 days). After 2 months, the cost of borrowing from the healthcare entrepreneur would have been cheaper than borrowing from a bank. Until borrowing from the healthcare entrepreneur is less costly than borrowing from a bank, the patient-customer has no incentive to pay his/her bill. 

Balancing the prompt pay discount with the patient-customer's incentive to pay

If one offers a modest discount and the patient-customer does not pay, one can predict a time in  the future when it would be to the patient-customer's economic advantage to pay.

If one offers a deep discount and the patient-customer does not pay, one can be nearly certain that they will not collect payment within a reasonable amount of time. In essence, the deep discount reveals those patient-customers on whom you cannot collect payment. That information helps in writing off the loss as *bad debt expense* and/or employ factoring of the receivable (more on that in another piece).