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May 26, 2022

What are net terms?

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Typically, businesses have problems with cash flow. On paper, the company may have success, but in reality, clients are late with covering invoices. As a result, companies have to face the consequences. In some cases, these consequences lead to bankruptcy.

Instead of waiting for customers to pay their debts, companies may consider implementing net term payments. According to the net terms system, clients have specific periods to pay, or they have to pay fees. In this article, readers will find out about net terms and how these terms help small businesses and suppliers.

Understanding Net Terms

A net term is a short-term credit extended by a company to its customer. Net payments are the total value of goods or services before paying taxes. Net terms reflect when an invoice is due after the billing date. In simple words, it’s the deadline by which a customer must return the payment in full to the business.

Typically, terms include the number that reflects when the invoice is due. For instance, net 30 means the payment is due 30 days after the billing date. Net 60 is due in 60 days, and net 90 is due in 90 days, etc.

Typically, companies prefer net 30, but there are other variations. Some payments even include discounts if customers pay early on.

How Do Net Terms Work?

If a company agrees to hand their customers credit and offer net payments, they have to choose a period when clients should pay. Typically, businesses choose between 30, 60, and 90 days. These are called net-30, net-60, net-90 terms.

Undoubtedly, companies with clients need to inform their customers that they are implementing a new payment system. Most businesses encourage early payments by offering discounts if they pay sooner.

Typically, the discount is 2%, and the period is 10 days. Such implementations help maintain a healthy cash flow, which is important for every business. However, most companies that use net-30 or other terms report that their clients are late when paying.

Regardless of the generosity of terms, around 64% of small companies report late invoice payments even if they offer 90 days periods. It’s an issue since companies have to find other sources of business funding to keep the most important business operations going.

Some businesses enforce a penalty for customers when they pay late. It is common to implement interest fees in case clients can’t meet net requirements. Check the example:

Suppose a company provides two clients $5,000 worth of services on net-60 terms with a 2% discount if they pay within 10 days (2/15 net-60). The company also implements a 2% interest fee each day a client’s payment is late.

The first customer meets the requirements to get a discount and pays within 7 days, so they pay only $4,900. But the second client is 5 days late with the payment. Given the interest penalty, the client has to pay $5,500. The payment keeps increasing every day.

What are net terms?

Why Should Companies Use Net Payment Terms?

The main reason to use net terms is to provide clients with a significant incentive to buy since they are allowed to delay payments. Most clients keep those products they receive, and the mechanism works for service-based businesses too. That way, the business offers better conditions to customers, and as a result, they pay, which is the key.

Net payment terms also provide businesses with awarding tool. Companies with loyal clients can award these customers by offering longer payment terms since they always pay on time. However, if a client often delays their payments, they could end up getting shorter payment terms.

Here are some other reasons companies may turn to implement net terms:

  • getting a competitive edge and securing new clients;
  • building relationships with clients;
  • growing a business with SMBs which have difficulties funding their purchases by other means.

Businesses may also maintain profitability by reducing processing fees related to credit card payments.

Benefits And Drawbacks Of Net Payment Terms

Undoubtedly, not any business can benefit from net terms. If a company is short on cash flow, net terms will only worsen the situation. So, let’s check the pros and cons of net terms from a business perspective.

Benefits

Quite a few benefits may attract business owners, be it a prospect of attracting new clients, or building trust with customers. Let’s check these advantages in detail:

  • Generating sales. Not every business can afford to pay for goods or services from the get-go. But if the supplier offers them net terms, these smaller businesses can afford the purchase. That way, businesses find more clients and thus, generate sales.
  • Getting an edge over competitors. Companies not offering net terms miss out on smaller clients. Instead, you can offer convenient conditions to businesses who can’t pay right away and thus, build a reputation and gain popularity in your area.
  • Building loyalty. Typically, new customers seek convenient terms. But within time, your quality services or products, customer service, and competitive prices make clients loyal to your business.

Drawbacks

Every system has its disadvantages, and the net terms option is not an exception:

  • Cash flow problems. Not every business can afford to spend months without cash. Growing businesses need funds if they want to keep up with their optimizations.
  • Some customers may not pay. The only way to prevent this issue from happening is to screen new clients’ ability to pay. Otherwise, the company may end up having a small portion of invoices unpaid.
  • Additional administrative responsibilities. Companies enforcing net terms have to manage invoices, keep track of accounts receivable, conduct regular invoice checks, keep track of net terms for each client, etc.

How To Implement Net Payment Terms?

Companies can choose where they want to add net payment terms. Typically, companies add terms at the bottom or on top of the invoice. Moreover, payment terms aren’t standard, so businesses may choose customized terms based on the client, their credit history, payment history, etc.

When choosing terms, analyze your company’s cash flow needs. Can your business secure a healthy cash flow when choosing a net-60? Or should you use net-30? Consider terms that make sense for your industry, clients, products, services you provide, etc.

Note: the implementation of net terms is more about building relationships and trust with clients. For instance, if a loyal client keeps paying on time or makes use of discounts and pays within 10-15 days, it’s recommended to extend their line of credit. If most clients pay according to net-60, offer loyal customers net-90 terms.

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Author: Charles Lutwidge

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