The Guide to Payment Terms (and How to Optimize Them)
Payment terms are essential in any business transaction as they define the cash flow cycle. They are the rules that ensure vendors and suppliers get paid on time and customers know when to expect payments. When discussing payment terms, we refer to the conditions that dictate when and how payments should be made.
Payment terms define when you get paid—at least regarding accounts receivable (AR). For accounts payable, payment terms usually refer to paying vendors and suppliers.
But regardless of who is paying who, the terminology is the same. The most significant difference is strategy.
Setting your payment terms means you set the cash life cycle. Of course, customers don't always abide by your terms — but failing to have them can result in chaos.
What do the Payment Terms Include?
Payment terms usually appear in two places: In the initial contract and every invoice. A payment term highlights when an invoice needs to be paid, how often, and if there are penalties for late payments.
When printed on an invoice, include the following:
- Invoice date
- Payment date
- Period for payment ("net")
- Invoice amount
- Rules for deposits or advanced payments
- Payment plan details
- Accepted payment methods
The payment terms included on the invoice must match the ones in the contract. B2C and eCommerce businesses have a "Terms and Conditions" page instead of a contract.
What are the Standard Payment Terms?
Payments have a unique vocabulary.
The one you probably know is the "net term." This is the period for accepting payments. If you have a Net-7 payment period, your customers should send the money within seven days of receiving the invoice.
There are several options: Net-7, 10, 15, 30, 60, or 90. Net-30 is the norm for most B2B businesses, but depending on your industry, it could be shorter or longer. In some cases, you may request immediate payment. This is common when taking advanced payments or a one-time project. But you can use a much longer list of abbreviations on your invoices.
Common Invoice Payment Terms
While using net payment terms is the norm for most industries, other jargon describes different payment patterns. Here are some of the most common acronyms and terms:
- 1MD: Monthly credit payment of an entire month's supply
- 21 MFI: 21st of the month following invoice date
- Accumulation discount: Discounts on large orders
- CBS: Cash before shipment
- CIA: Cash in advance
- CND: Cash next delivery
- COD: Cash on delivery
- Contra: Payment from the client, offset by the cost of supplies purchased
- CWO: Cash with order
- EOM: End of month
- Forward dating: Invoicing for payment to be made after the customer gets the order
- Partial payment discount: When a seller offers a partial discount due to low cash flow
- PIA: Payment in advance
- Preferred payment method discount: A lower or "zero-fee" transaction for customers who pay with your preferred method.
- Rebate: Refund sent to the buyer after they've bought a product or services
- Stage payments: Set payments over a period of time
- Trade-in credit: A discount for something that is returned
Should I Charge a Late Fee?
One method of reducing late payments is to highlight a late payment fee. Organizations with a high percentage of high-risk transactions would likely want to use this to deter intentional delays.
The average late fee ranges between 1% to 1.5%. While it may seem low, it does incentivize customers to pay on time. It also is low enough to avoid allegations of usury.
When implementing a late fee, it's best practice to:
- Offer a brief "grace period" in case of unanticipated delays. This can be anywhere from 3-7 days.
- Reference the specific late fee in both the contract and individual invoices
- Remind customers of the potential late fee in your collections process
Dealing with Unpaid Invoices
Let's assume you have your payment terms in place, and all clients have agreed to them via a signed contract. You've decided to stick with the Net-30. What does this look like in real time?
According to Deloitte, it takes about 30 days to complete payment, and 47% of suppliers are paid late. While payment terms can help streamline the process, they are the prologue, not the last chapter of the payment process.
Late fees can help. But you'll also want a sound collections strategy to improve cash flow. There are three ways to do this:
- Call and email your customers until they finally pay up.
- Hire a collection agency to shake off the bad debt (and give them a slice of the pie).
- Create an automated collections follow-up sequence and spend time on the real offenders.
In the worst-case scenario, you can threaten a non-paying customer or take legal action and file a claim. But this can reduce customer base trust, affect insurance premiums, and you may end up with a legal bill bigger than your payout.
Accepting Different Payment Methods
Offering many payment options as possible is ideal. Choice makes it convenient for customers and also makes it harder to say "no" when you're selling to prospects.
But there's a hierarchy here as well. For example, you may prefer ACH and bank-to-bank transfers and offer credit card payments for convenience. With the right payment platform, you can turn the credit card processing fee into a convenience fee to push customers towards more affordable options and cut costs.
Likewise, you can offer "zero-fee" payment options to promote your preferred method.
To incentivize and discourage payments, you need a range of options. For example, if you only accept credit cards and have a convenience fee, the added cost could create friction in the long term. However, giving customers a second or third option makes it seem more reasonable.
What are the Standard Payment Terms by Industry?
Every industry has its payment terms. In terms of payment period:
- Agriculture: Immediate to 3 days
- Auto Repair: 30 to 90 days
- Cleaning: Immediate to 14 days
- Construction: 30-90 days
- Finance: 30 days
- Food and Beverage: Immediate to 3 days
- Insurance: Immediate
- IT: 30 days
- Marketing: 30 days
- Manufacturing: 30-60 days
- Medical Supplies: Immediate-30 days
- Landscaping: Immediate to 7 days
- Professional Services: 14-75 days
- Retail: 3-7 days
- Renewables and environment: 30-60 days
- Transportation: 30 to 120 days
An organization's size can also affect its payment due date. Smaller businesses tend to have faster cash lifecycles, but larger enterprises may take 60 or 90 days for payment. This can be due to several factors, such as their accounts payable concerns and quarterly supplier deals.
Getting Creative with Payment Terms
The goal is to have customers pay on time or earlier than the due date. You can offer small discounts, such as 2% or 5%, for early payments. For example, consider having a Net 30 but offering a 5% discount for clients who pay within seven days.
And this logic applies to preferred payment methods, too. You may give clients who pay with ACH a 2% discount over those who pay with a check or credit card.
It's also possible to extend your customers a line of credit, mainly if you've worked with them long. A customer credit line allows them to settle bills over time, usually monthly or quarterly.
While this does decrease your cash flow, it can be a way to keep larger clients. Since there is a higher degree of risk, it's better to be selective using this strategy.
The biggest challenge is ensuring that your accounting software or ERP can handle customized invoicing. The last thing you want is to change the default payment term for each invoice and manually review monthly credit payments.
The more detailed the payment terms and the more customized your payment strategy, the larger the margin for error becomes when performing AR tasks by hand. If you plan to streamline your standard payment terms for a better customer experience and faster payments, it's best to automate the AR process.
How Do You Tell Customers About Payment Terms?
For B2B companies, the contract is the first place a customer will see and agree to your payment terms. Usually, it's written up in a lot of legalese. For example:
Section 5. Billing and Payment Terms. (a) All amounts due under this Agreement shall be billed and paid for in the following manner (i) Company A shall invoice the customer every month for the supplies that Company A delivered or caused to be delivered during the preceding month, (ii) each such invoice shall be payable within 30 days after the date of the invoice, (iii) payments late by seven days will accrue 1% in late fees per month until the invoice is paid, and (iv) payment of all invoices in respect of the Services provided hereunder shall be made in U.S. Dollars.
Adding payment details to an invoice is often shown at the top.
In a web portal for online payments, the payment terms show at the top, as in a traditional invoice, after the payment options, or as part of a separate "terms and conditions" page.
Advanced Payment Terms and Conditions
Advanced payments offset potential non-payment and are used when working with a new customer. These payments are made before a service or product is delivered, and businesses benefit from the immediate cash flow.
If you plan to request an advanced payment, you can ask for 25%, 50%, 75%, or 100% of the payment upfront. This depends on your reason for requesting an advance and may be negotiated. For example, you may only need 25% of an advance to order the initial supplies required to complete an order.
When designing an advance payment option, it's essential to lay out critical information:
- Timeline of deliverables
- Payment milestones, if applicable
- Process in case of non-delivery
Get Paid Faster By Keeping Payments Simple
The easier it is for your customers to pay, the faster you'll get paid. But reducing friction doesn't have to be a complicated process. The cornerstone of being user-friendly is being clear. First, write them in plain English in your contracts and invoices.
But there's more you can do.
Self-service payment portals, accepting multiple payment methods, secure payment method storage, automated collections, and verified receipts are all customer-centric initiatives that keep your books organized. Paystand is a solution that integrates with your ERP or accounting software. You can sync your invoice data in real-time and streamline your AR process.
Spend more time on what matters—forecasting, strategizing, and following up with new or high-risk payments—without worrying as much about cash flow.
At Paystand, we offer all these features and more. Book a demo today to find out if we're a good fit for you and your team.