Building a consistent cash flow for your business will help alleviate the impact of potential financial issues down the road. To decrease the amount of bad debt within your business, one tactic is to provide customers with early payment term discounts.
Before jumping into providing prompt-payment discounts, businesses first need to decide two things:
Are early payment terms right for my industry and the nature of my business?
Are the early payment terms profitable for the business at the current time when performing a cost-benefit analysis?
A common invoice payment term is Net 30. While Net terms have become common place throughout a majority of industries, this payment style is still an incentive because it reaffirms with the customer that you trust them enough to provide your product or service without immediate or prior payment.
The company is still required to pay the full sum of the invoice, just 30 days after the invoice is received by the company, providing the customer greater flexibility.
Common Net Terms are: Net 15, Net 30, Net 45, and Net 60.
Tip: We find that by using the word “days” instead of “net” on the invoice customers are more likely to pay their invoices and pay them faster.
Payment Term Discounts
So what payment terms are most commonly used?
Here are a few examples:
2/10 net 30
o Definition: The customer is required to pay within 30 days of when the invoice is received. The customer will receive a 2% discount if they pay within 10 days of receiving the invoice.
o Common variations: 2/10 net 40, 2/10 net 60, 1/10 net 30, etc.
o Should you Use It: This type of rate is ideal for businesses that to have cash as quickly as possible because it speeds up the cash cycle. Businesses should review the Credit Terms Table at the bottom of the post to see the interest impact by extending the terms.
o 3/7 EOM
- Definition: The customer will receive a 3% discount if the invoice is paid within 7 days of the last day of the month indicated on the invoice. If the invoice is received on or before the 25th day of the month, then the payment would be due on the 7th day of the next calendar month.
o 3/7 EOM net 30
- Definition: The customer is required to pay within 30 days, but will receive the 3/7 EOM discount if paid in advance, given the terms listed above.
o Should you Use It: For the means of early payment to decrease bad business debt, EOM terms can be more confusing for customers because it is not as clear for when the payment is due.
o 2/15 net 30 ROG
- Definition: The customer is required to pay within 30 days of receipt of goods, but will receive a 2% discount if paid in 15 days of receiving the invoice.
- Should you Use It: Industries often uses the ROG terms when buyers cannot expect delivery until a long time after they place the order.
Partial payment discount or program
If the company is in need of immediate cash flow, a partial payment program could be a good solution. Often companies provide a 30-30-40 program, where customers are required to pay 30% up front, 30% at the time of the invoice and 40% on terms following the receipt of the invoice.
Credit Terms Table
The table below provides a few examples of the effective annual interest rate when offering credit terms. This can help when completing the cost-benefit analysis.
The interest rate for any payment terms can be determined via this calculation:
Discount %/(1-Discount %) x (360/(Full allowed payment days – Discount days))
|Credit Terms||Effective Interest|
|Net 10 EOM||None|
|1/10 Net 30||18.2%|
|2/10 Net 30||36.7%|
|1/10 Net 60||7.3%|
|2/10 Net 60||14.7%|
(Adapted from: http://www.accountingtools.com/credit-terms-cost-of-credit)