The Ultimate Guide to Payment Terms & How To Optimize Them

Published on May 7, 2024
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Many factors can go into setting payment terms for your customers, particularly for large or recurring sales. These terms outline not only how much a buyer owes you but whether particular buyers can pay you in installments when they need to have the full payment ready and what the consequences will be if their payment is delinquent.  

Optimized payment terms consolidate these critical details — the what, why, and how — into a common, centralized, and contractually obligated format. In this article, we’ll explore common payment terms and how to optimize them so you can get paid faster. 

Why are payment terms important? 

Payment terms are crucial in streamlining business-to-business (B2B) sales interactions.  Unlike consumer transactions, in which payments often occur upfront and with an immediate exchange for goods, B2B deals typically involve a delay between the delivery of the product and the actual payment. This delay is based on a promise to pay later, which can offer flexibility to your customers but also creates opportunities for payment challenges. 

Having clear payment terms is essential for managing cash flow effectively. Not knowing precisely when funds will come into your bank account limits when you can send money out of that account to cover your operating expenses and purchases. Well-defined payment terms help eliminate much of the guesswork surrounding payment timelines while providing clarity — and accompanying incentives — to discourage your customers from not paying on time.

What are the payment terms on an invoice? 

You’ll want to inform current and potential buyers of your payment terms early on and often. Your buyers will most likely notice payment terms when they are outlined on your invoices, but they can also be found on initial contracts, company websites, or other sales materials. 

The invoice terms that you’ll want to include on every payment request are the following:

  • Invoice date
  • Payment due date
  • Late fees
  • Amount due
  • Discounts (e.g., early payment discount, accumulation discount)
  • Rules for deposits or advanced payments
  • Payment plan details
  • Accepted payment methods
  • Currency requirements

These terms ultimately highlight when and how often payments are due, as well as any penalties for late payments, to ensure your business gets paid. 

Common invoice payment terms

Given the vast amount of detail you need to include on a given invoice, many fields and descriptors rely on short-hand labels and acronyms to save space. If you’re new to invoicing, some of these turns of phrase can be difficult to parse. Here are some of the most common invoice terms you’ll need to know:

  • 1MD: Identifies a credit payment for an entire month’s supply
  • Accumulation discount: A pricing reduction for larger orders
  • CBS: Cash before shipment — the purchased item will not be shipped until payment is received
  • CIA: Cash in advance — a strategy that moves all of the risk to the buyer, requiring upfront payment before anything is produced or shipped
  • CND: Cash next delivery — commonly used for reoccurring purchases or subscription plans, this descriptor indicates that full payment is due before the next delivery date
  • COD: Cash on delivery — the payment must be rendered at the time of product or service delivery
  • CWO: Cash with order — an alternate phrasing for cash in advance
  • EOM: End of month — typically used to identify that a payment is due on the last day of the same month as when the invoice was created
  • Forward dating: Indicates that the invoice date has been artificially pushed back (commonly until after the delivery date) to offer the buyer more time before the payment terms take effect
  • Partial payment discount: During times of low cash, a seller might offer special price reductions for partial invoice payments made within a set time period
  • PIA: Payment in advance — an alternate phrasing for cash in advance
  • Preferred payment method discount: A price reduction or waived processing fees when a buyer pays through a specific, favored channel, such as an automated clearing house (ACH) payment
  • Rebate: A full or partial refund is sent out to the buyer after payment has been rendered
  • Stage payments: Reoccurring partial payments that transpire over a set period of time
  • Trade-in credit: A discount applied to the buyer’s account after an item was previously returned
  • Upon receipt: The payment is due when the buyer receives the invoice
  • X MFI: A due date that occurs on a specific day of the month following the invoice date, where X = the specific date of the month 
  • Y/Z Net X: A common descriptor for an early payment discount where Y = the percentage of the discount, Z = the number of days that the discount is available after the invoice date, and X = the number of days after invoicing when full payment is due

Types of payment terms

Now that you know how payment terms work and what they mean, the next step is to decide how you will accept payments. Some of the more common plans are:

Immediate payment

The most low-risk option, terms that require immediate payment upon delivery, eliminates the possibility of generating bad debt. However, this approach will also severely limit the size of your potential customer pool, given that many buyers will want to leverage their payment timelines to enact more nuanced control over their cash flows.

Installment agreements

For larger, long-term projects, consider installment agreements that allow buyers to break up their purchases over multiple payments. The timing for these sub-charges can be based on a set period or triggered when certain project milestones are reached.

Lines of credit 

Predominantly offered by larger businesses, a line of credit allows buyers to finalize an initial purchase while extending the actual payment timeline. In contrast to an installment agreement, lines of credit typically set a minimum monthly payment — commonly a percentage of the total balance — that needs to be rendered during each pay period. The outstanding balance, in turn, is charged an ongoing interest rate until the total balance is paid in full.

Net X 

Also known as the standard payment term, this approach reflects one of the most straightforward and common credit-based payment options. The “X” indicates how many days the customer has after the invoice has been created to render payment without incurring late fees — typically 7, 10, 15, 30, 60, or 90 days.

Partial payment 

Partial payments are a hybrid approach in which a certain percentage of the total invoice amount must be paid within a specified timeframe before the full payment is due for the entire purchase. With this approach, sellers can better control and predict their cash flows without placing too much of a financial burden on buyers. Typically, partial payment terms are only offered for brief periods.

Prepayment

An advanced billing strategy will improve your cash flow and shift nearly all transactional risk to the buyer. However — just as with immediate payment terms — solely offering this payment approach will artificially limit the available pool of potential customers that you can reach. Typically, businesses that offer prepayment options will bundle these with a corresponding discount that encourages prepayment without demanding it.

Subscriptions and retainers 

These subscription payment strategies, common among software vendors and service providers, establish an ongoing cost for the relevant offering that must be paid on a recurring basis to maintain access.

How to use payment terms 

Your payment methods should align with your sales cycle, business plans, and cash flow needs. You have the flexibility to adjust these methods based on changes in your financial situation. It’s important that your payment policies benefit your business and provide advantages for your customers, such as flexibility, control, competitive pricing, and incentives for positive payment behavior. 

Payment terms example 

As we’ve previously mentioned, you’ll want to document all relevant payment terms on every invoice you send out. Typically, these details should be centralized into a handful of areas on the actual invoice. Let’s take a look at an example invoice with several payment term elements:

Payment terms example on an invoice

How to optimize your payment terms so you can get paid faster 

Most payment terms are designed to provide flexibility to your customers and attract new business. However, being overly generous with these terms can quickly eat away at your cash reserves and threaten your business’s financial health. As such, when establishing payment terms, you should also utilize them to incentivize faster payments—particularly since the more time that passes after an invoice has been sent, the less likely that the bill will actually be paid.

Some effective strategies you can try are to:

1. Charge a late fee

Typically, your customers want to pay the lowest possible price for their purchases, so applying additional charges to past-due invoices will often encourage prompt action. Of course, you’ll need to balance this “punitive” measure against the potential annoyance to your customers — with most organizations keeping this fee between 1% to 1.5% of the total amount due.

If you choose this approach, clearly document the potential late fee in the initial contract, submitted invoices, and any payment reminders. Consider applying an internal grace period of a handful of days before adding these fees to a customer account to allow for short, unexpected delays.

2. Automate your collections follow-up 

Ask yourself this: How much time and effort do you want to spend chasing after your money? Yes, you can dedicate multiple employees to your dunning efforts — the various phone calls, emails, and texts you send out as reminders for payment. But is that the best use of their time?

Automating these efforts can significantly benefit your A/R team. For instance, utilizing features like Invoiced’s Smart Chasing as part of our Accounts Receivable Automation software can deliver consistent, repeatable reminders to your customers through multi-channels. This approach helps ensure that your customers stay aware of their outstanding debt, keeping it at the forefront of their attention. 

3. Accept different payment methods

This strategy will offer more convenient options for your customers to close out their purchases and open up a broader market of potential buyers. Of course, not all payment types — and their accompanying processing fees — are equally lucrative for your business. So, while you should offer a broad set of payment options, prioritizing cost-effective channels will benefit your bottom line. Alternatively, you can charge customers convenience fees or other costs to cover processing expenses more effectively. Invoiced’s A/R software makes it possible to add these fees when applicable. 

4. Leverage early payment discounts

Another strategy that directly impacts your customer’s bottom line is early payment discounts, which take a more positive approach to encouraging prompt responses from buyers. These price reductions reflect a 1% to 2% discount on average. Typically, you’ll only want to offer this incentive for limited periods — particularly when facing a temporary drop in cash flow. Depending on your profit margins, maintaining such a price reduction for an ongoing period could quickly eat into your financial progress and overall business growth.

5. Request an advanced payment 

This approach is commonly reserved for new customers or buyers with a poor credit history. While you can ask for the total payment upfront, it’s often wiser to ask for only the amount that covers material costs and initial labor for the product or service. With this approach, businesses can limit risk exposure without overburdening the customer.

If you do opt for this approach, you’ll also want to amend your payment terms to outline any protections for the buyer, such as obligated delivery timelines and the refund process in the event of non-delivery.

6. Offer customizable payment terms 

Not all customers will be in the same financial situation, so it’s important not to take a one-size-fits-all approach to your payment terms. You should provide buyers with options not only in the type of payment terms but also in their underlying conditions. 

Some businesses—particularly those with a longer sales cycle—might need Net 60 terms, or they might be more responsive to a 2/5 early payment discount over a 1/10 one. The more closely you can match the incentives and options that you offer to your customers’ unique business needs, the more likely your customers will choose your business as a preferred vendor.

Of course, accommodating these varying conditions can quickly become complicated to manage. Investing in an automated payments platform is one solution that allows self-service payment controls that can natively manage automatic payments, short payments, discounts, taxes, fees, and more. With Invoiced Accounts Receivable software, you can create customized payment terms on a customer-by-customer basis and, if desired, invoice-by-invoice basis, all while maintaining the automated nature of your dunning efforts.  

Create customized payment terms and get paid faster  with Invoiced

Invoiced is an all-in-one Accounts Receivable solution that offers a wide range of strategies to optimize your payment terms. Our software gives you nuanced control over your payment terms and the ability to set company-wide standards or create individual conditions for each unique customer or invoice. 

At the same time, our platform can automatically process deductions, apply discounts, and chase payments with little human intervention. The built-in payments portal empowers buyers to place orders, review invoices, finalize payments, dispute charges, and negotiate terms from one interface.

Schedule a demo today to explore how you can get paid faster using our A/R automation software.

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