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How To Set Reasonable Payment Terms

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Posted by Brett Romero - 28 August, 2019

How To Set Reasonable Payment Terms

Allowing customers to pay on terms is a great way to grow your business. Depending on the industry, customers will even expect to pay on terms. Payments terms need to work for you and not just the customer. You don't want customers paying for products or services 90 days later when suppliers must be paid within 45 days. That would create a cash flow problem.

Creating reasonable net terms is a matter of offering benefits and options to the customer. In this article, we'll explore what those benefits and options look like.

Setting Net Terms

As mentioned above, customer payment terms need to align with your supplier payment terms. You want customer money coming into the company just as it is going out to suppliers. A little bit of padding doesn't hurt anything. For example, if suppliers must be paid within 50 days, invoice payment terms can be set at 45 days, creating 5 days of padding.

Any terms and conditions that are set should be part of your accounts receivable policy. A policy is a living document that everyone can refer to. It's called a living document because it is kept up-to-date. It will contain your entire accounts receivable process when to send out late notices, when to turn an account over to collections, how to set terms for customers, and more. 

Policies also allow for consistent training. When a new employee joins the accounts receivable team, they don't have to worry about tribal knowledge and to try to learn everything from the guy that's leaving the company in two days. Everyone will be on the same page.

Offering Early Payment Discounts

Part of any accounts receivable policy includes documentation on early payment discounts. Discount terms can be specified explicitly on invoices. For example, 2/10 - net 30 means the customer will receive a 2% discount for paying 10 days early. Otherwise, the invoice is due in 30 days.

goods or services

How to set an invoice due date and discount terms may be dictated by your industry. Otherwise, it is left up to the small business owner. You have to figure how much of a discount you can set without it eating too much into margins. How much is "too much" means you should be able to cover all cost and make close to your profit margin on the specific service or product. If giving up 2% for 10 days adds benefit, then the discount is worth it overall.

Payment Plans

Payment plans can be another great way to add customer benefits to your payment policy, further setting your company apart from the competition. Payment plans also provide an opportunity for your business to earn additional revenue through financing. Or stated differently, customers don't get to pay notes on their product or service for free.

Any payment plan can charge a market interest rate. That rate can then be bundled into payments. As an example, if the invoice amount is $10,000 and the customer wants to make four payments over 6 months, that's $2500 every 1.5 months. However, you will charge a fee for financing the customer. If you charge a reasonable rate of 10% interest, that's $1000 total interest over 12 months. However, the customer is only financing for 6 months.  To figure the interest amount, use the following calculation: $1000/365 = $2.70 per day. Each payment period is 45 days, which means 2.70 x 45 = $121.50 or $2500 + $121.50 = $2621.50 per payment.

The above numbers are only approximations. It is certainly up to the company's digression as to how much in financing fees it wants to charge. Just as offering credit terms allows a business to grow by accepting more customers, so do payment plans. Some customers, especially startups, will need the option to split payments across terms and will pay extra for the convenience.

Payment Methods

More and more B2Bs are offering a larger variety of payment methods.  While not as many as B2C, it's certainly more than just a few years ago. Accepting credit card payments are now common with B2Bs as is eCommerce. Both areas dominated by B2C. However, B2B is starting to take a few pages from the B2C playbook.

receive payments(source)

At least for B2Bs, there may still be some purchases that are too large for credit card payments. Mainly because of processing fees. There are ways around fees for large ticket items. One is to add on a surcharge for credit cards. The surcharge can be equal to the processing fee amount. Another method is to get a reduction in fees. Check with your processor on how that is done. Usually, it involves gathering more customer information for a purchase. These methods can be used together to reduce fees further.

When setting payment terms, it's also critical to ensure you have a thorough, well-documented approval process. Finding out how creditworthy a customer is will determine their credit terms, discount offerings, and risk.

Summary

In today’s blog you learned the basics about payment terms including:

  • You should set net terms to align with your supplier payment terms so that there is consistency
  • When offering early payment discounts figure how much of a discount you can set without it eating too much into margins
  • Payment plans provide an opportunity for your business to earn additional revenue through financing
  • Offering different payment methods for your customers allows 
B2B eCommerce Marketing
 

Topics: Payments, Payment Processing, Net Terms

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