Many small businesses face issues with cash flow due to late payments from their customers. Being upfront and clear with payment terms is a vital part of getting paid on time.
The lack of capital or cash remains the most cited challenge for small business owners, at 32 percent of the share of respondents. - 2020 Small Business Trends, Guidant Financial
Are you facing issues with cash flow due to late payments from your customers? One of the many ways to encourage customers to pay in a timely fashion is to optimize your payment term given.
Being upfront and clear with payment terms is a vital part of getting paid on time.
In this article, we cover:
- What is a payment term?
- The importance of having clear payment terms while invoicing
- Five commonly used payment terms and how they can be displayed in an invoice
- Tips to encourage customers to adhere to the given payment terms
To learn more about improving your invoices, check out our invoice guide here.
What Is a Payment Term?
A payment term indicates the period given before payment for an invoice is due. The payment term is usually presented in your invoice, and in best practice, it should be determined before doing business with a new client.
Why Is It Important to Have Clear Payment Terms in Your Invoice?
Speedier Payment
By laying down your payment terms, you inform your customer of your expectations when payment is due. With a definite date in mind, customers will be more mindful of the pending deadline. Using additional conditions such as late payment fees or discounts when early payment is made can further incentivize your clients to pay on time.
Allows For Better Cash Flow Forecasting
With established payment terms, you have a better picture of when your cash inflows from invoice payments are scheduled. Equipped with this information, you can budget for future projects and upgrades and manage your cash flow.
Maintains Good Customer-Supplier Relationship
Having clear payment terms established early in your customer-supplier relationship minimizes any confusion and sets the bar of what is expected. Both parties would naturally prefer payment terms that are more beneficial to them, but a compromise must be made.
Without establishing payment terms, there might be a dispute when an invoice is issued, and payment is due, as both parties will insist on their preferred payment terms. Maintaining good relations with your client is crucial in promoting recurring orders and customer retention, so it is better to decide on the terms beforehand to avoid unnecessary conflict.
Commonly Used Payment Terms
Here are some widely used payment terms. Even though these payment terms might be considered commonplace, it is always better to include them as easy-to-understand sentences in your invoices. Therefore, we have added examples of simple but clear phrases describing each type of payment term that you can use in your invoices.
1. Cash on Delivery (COD)
Also known as Payable on Receipt or NET 0, cash on delivery means that upon delivery of the goods or services, payment must be made. This can be useful if you’re a new business looking to build trust in customers as it greatly benefits the customer.
Example of how this can be displayed on an invoice:
“Please make payment once you have received the goods.”
2. NET 15/30/45/90
NET x indicates the number of days (x) given before payment is due. Therefore, NET 15 will mean that payment is due 15 days after the invoice date, NET 30 for 30 days after the invoice is issued, and so on. You should pick a suitable timeline that allows you to collect payment without pressuring your customers and jeopardizing the customer-supplier relationship.
Example of how this can be displayed on an invoice:
NET 30: “Please make payment after 30 days of receiving this invoice.”
Companies that offer longer payment terms to cultivate an excellent customer-supplier relationship might struggle with maintaining steady cash flow. Invoice factoring can tide you over extended periods of slow payment by providing you with a percentage of your invoice’s value upfront. Read more about invoice factoring here.
3. 2/10 NET 30
While seeing “NET 30” alone means that payment is due in 30 days after the invoice is issued, “2/10 NET 30” adds the option of enjoying a 2% discount off the outstanding amount if payment is made within 10 days. Offering incentives for prompt payment encourages customers to pay earlier for them to save on their expenses.
The breakdown of this payment term is:
x/y NET z
where:
- x is the percentage discount given
- y is the days the payment must be made to enjoy the discount
- z is the overall payment deadline
Of course, these values can be tweaked to suit your business needs, such as “5/7 NET 45” (5% discount if payment is made within 7 days of the invoice date).
Example of how this can be displayed on an invoice:
2/10 NET 30: “Please pay within 10 days to save 2%.”
4. End of Month (EOM)
End of Month means that payment is due at the end of the month. Companies who use this generally want to receive compensation for their work in the same month as their invoices issued.
However, depending on the invoice issued date, EOM can also mean a very tight deadline for your customers. This payment term should only be used if you send invoices out on the same day every month while considering each customer’s ability to pay within that timeline.
Example of how this can be displayed on an invoice:
EOM for June 2020 issued invoice: “Please pay the invoice by the end of June 2020.”
5. Month following Invoice (MFI)
Month following invoice (MFI) can be a tricky payment term to implement as it highly depends on the date the invoice is issued. The number before “MFI” determines the upcoming date when payment is due. If the payment term is “15 MFI”, it means that payment is due on the 15th of the month following the invoice date.
For 15 MFI, there are two possible scenarios:
1. The invoice is issued on a date after the 15th
Invoice dated 17th January with payment terms 15 MFI - payment is due on 15th February.
2. The invoice is issued on a date before the 15th
Invoice dated 2nd January with payment terms 15 MFI - payment is due on 15th January.
Therefore, be mindful of the invoice date before using MFI as a payment term as it can result in an unexpectedly late payment.
Example of how this can be displayed on an invoice:
15 MFI: "Please pay on the 15th of the month following the invoice date."
In addition to the abovementioned payment terms, there are also options for prepayments, such as deposits or staged payments. A downpayment can help improve cash flow, especially if the fulfillment of an order takes months.
Read up more about deposits and staged payments in our article here.
How to Encourage Clients to Adhere to Your Payment Terms
Draw up the payment terms before starting any work for your clients
Disputes over invoices are often made because of unclear payment terms. These can be avoided by writing up a formal agreement with the payment terms clearly stated before starting any orders. With this agreement, you can discuss and come to a compromise with your client on the payment terms where both parties are comfortable.
Additionally, this further justifies your claim for late payment if your customer happens to miss out on the payment terms printed on the invoice.
Compare payment terms with the industry standard
Your offered payment terms should adhere to the same period as what is typically provided in your business industry. You can even give longer payment terms to set yourself apart from your competitors. However, make sure that your business cash flow is sufficient to tide you over when using these extended payment terms.
Provide a variety of payment methods
No one wants to set up an account for a payment service they are unfamiliar or uncomfortable with, just to make payment for one invoice. Offering a variety of payment options grants your customer flexibility and removes a potential barrier to getting paid on time.
You can take it a step further and offer discounts to customers paying via your business’s preferred payment methods.
Add in additional penalty fees in the event of late payment
Late payment fees can come in the form of a fixed amount of % interest charged after a certain number of days. Adding in conditions for late payment can encourage your customers to pay on time. However, these should be communicated early with your customers to avoid straining the business relationship.
Incentivize early payment
Instead of late payment fees, you can also implement early payment discounts. Customers can be incentivized to pay earlier than the due date if a rebate is offered. Just make sure that these discounts offered makes business sense and do not take away too much from your profit margin.
In conclusion, setting clear payment terms when invoicing your customers is vital in getting paid on time and improving your cash flow. Establishing payment terms allow you to get paid quickly, forecast your business cash flow for better budgeting, and minimize conflicts regarding payment down the line. However, be mindful of your payment terms used before issuing an invoice, as it could mean delayed payments or unreasonably short timelines for your customers.
Additionally, you can encourage customers to stick to the payment deadline provided in many ways, such as supporting a range of payment methods or rewarding early payment with discounts to the full outstanding amount.
To learn more about invoicing and other aspects that can encourage timely payment, check our comprehensive invoice guide.
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