Simply put, payment terms refer to the payment conditions mentioned by the seller to the customer. Though this sounds like just another term in your sales documents, an organization payment term has a lot of impact on the business itself.
Payment terms that you decide for your business affects your cash flow and how much business you can generate. It also plays a major role in how much capital you need to keep invested in your business.
Your invoices and quotations should clearly indicate the payment terms. This ensures that you receive your payments on time. Some organisations may insist on a part payment to accept the order and then collect the remaining payment on completion of the sale. Whereas some other organisations may collect the payment on delivery. Payment terms are not standard rules but are decided by the organisation based on multiple factors.
To make sure you are properly adding the payments terms in your documents you can download one of our templates for quotations and invoices. By using the templates you simply need to fill in the fields according to your business needs.
Common payment terms used in Quotations and Invoices
Before we dig deep, let’s take a quick look at some of the common payment terms used by businesses.
- PIA or Payment in Advance in which case you deliver the product or service only if the complete payment is made in advance.
- Net X days: Where X represents the number of days from the invoice date with which payment needs to be made. For example, “Net 7 days” means that payment needs to be made within 7 days of the invoice date. Similarly you may mention “Net 10 days”, “Net 15 days” and so on.
- EOM: End of Month, meaning that the customer is supposed to make the payment at the end of the month.
- COD: Cash on delivery
- X% Advance: Where X represents what percentage of the value needs to be paid in advance
- CIA: Cash in advance
- 2% 14 Net 30: Such a format is used to give a discount to the buyer if the payment is made within a certain number of days.
In this example, the buyer gets a 2% discount if the payment is made within 14 days of invoice date. If it is not so the complete amount needs to be paid within 30 days.
- 1MD: Monthly credit payment for one full month’s supply.
Sometimes sellers agree to keep supplying goods to trusted buyers and settle the payment at the end of a particular period of time, usually in months. In such cases the payment term is mentioned as 1MD, 2MD etc.
- Milestone payments: For large projects, the payment is usually released as per the completion of certain milestones. In such cases both buyer and seller agree on milestones. This define what part of the total amount is to be paid to the service provider for each milestone.
Why is the payment term important for your business?
Let’s say that your organization sells only on getting 100 percent payment in advance. But you have lots of competitors and you do not have any significant differentiation that customers appreciate. In this case, your chances of closing deals will be less and revenue growth will be slow.
Consider you purchase a costly raw material, convert it into finished goods, and sell them to your customer. If you have to pay your suppliers before your customers pay you, you will need to invest more capital as you sell more.
In the worst case, the client doesn’t show up after you deliver a product and service without an advance payment. In this case, you have lost both your profit and the cost you incurred.
Payment terms that your organization needs to follow should be carefully decided after considering your competition, business model and what type of customers you deal with.
If your business primarily involves repeat business with few customers, you may be okay with giving a relaxed credit period. But if your business mostly involves one time sale to individual customers or companies, it is best to ensure at least a part payment.
At the same time, if your customers are large companies, they may have a proper vendor onboarding process and well defined payment policies which you will have to adhere to.
Why should you standardize your payment terms?
If you have multiple sales executives, then it is best to clearly define what should be the payment terms for different customer groups. This ensures that your cash flows are predictable and different sales executives do not put random terms in each document that is sent to customers.
Though you may be flexible with the payment terms in the initial days, as your business grows, it will become increasingly difficult to collect payments if you do not standardize payment terms.
Payment terms for freelancers
If you are a freelancer, it is most likely that you have faced situations where the customer did not pay you after the work was completed.
This happens mostly because as a freelancer or small business owner you might not have the resources to chase the customer legally.
It is always better that you collect some amount in advance or agree to milestone-based payments such that your cost gets covered before the final payment.
Willingness to pay an advance amount or retainer fee also shows how serious your customer is about getting the work done. There is no dearth for people who use your time to get free advice and then go cold when you talk about starting the work.
How can you collect payment from overseas customers?
If you are a freelance web developer, designer, content writer or working on similar lines, it is most likely that you are working for an overseas customer.
So how do you collect advance payment before starting the work? Bank transfers are time consuming and costly if your customer is from another country. And most banks do international transfers through intermediary banks which means that you don’t get to know the status of the transfer unless the amount finally reaches your bank account.
The best alternative here is to invoice your customer through software such as Zenys and ask your customer to directly pay you through Zenys. Zenys supports payments through international debit and credit cards which avoids the need to interbank transfers and the subsequent delays.
Zenys will update your account with the amount received as soon as your customer makes a payment. This way, you can start the work confidently and the payment will be transferred as per the payment gateway’s terms.
Payment and shipping terms in export scenario
Though lucrative, exporting goods involves significant risks with payment collection. Hence it is very important that you carefully define and follow payment and shipping terms when you deal with overseas customers.
Here are some of the commonly used payment terms for export scenario :
- Open account refers to the payment scenario when the importer pays the exporter after a fixed time period (credit period) post receiving the goods. Exporters agree to this term when the importer is well known to them through prior business associations. Also if the importer is a renowned and reputed large organisation.
- Payment term CAD or cash against document refers to the scenario when the exporter sends the documents required for clearing and receiving goods by the importer to the importer’s bank. The importer makes the payment to the bank. He then collects the documents and the importer’s bank transfers the amount to the exporters bank account. Payment term DP or document against payment also refers to the same scenario where the documents are released from bank to the importer on receiving payment.
- The payment term DA or Document against acceptance is a modified version of CAD. Here the importer makes a promise to it’s bank to make the payment and collects the clearance document. This essentially means that the importer gets some amount of credit period. The importer’s bank makes the payment to the exporter’s bank once the importer makes the payment.
- Payment term LAC or letter of credit means that the importer’s bank gives a written commitment to the seller. It clearly indicates that the payment will be made to the seller as per the mentioned timelines.
- Cash in advance as the name suggests requires the importer to pay the exporter to ship the goods.
So while deciding what payment terms you should offer, consider multiple factors such as your competition, relationship with customer, nature of customers and impact on your finances.
Once you decide on the payment terms for your customers, make sure that you consistently follow it as far as possible to minimize collection woes.