What Are Net Terms on an Invoice & How to Interpret Them
September 27, 2023
The net terms on an invoice represent the flexible payment options that cater to both the customer's and the business’s needs and allow them to meet halfway in completing each end of the bargain.
Securing a steady cash flow while also underscoring customer convenience and enabling ways to keep operational expenses manageable is crucial for businesses to thrive and boost customer loyalty.
So, if you’re eager to learn more about net terms and understand how they can benefit your venture, this article is your perfect guide.
- Net terms are conditions of payment either in the form of net 15, net 30, net 60, or net 90. The terms depend on the nature of the transaction and the seller-buyer agreement.
- Offering net terms to customers effectively encourages customer loyalty, retains existing customers, boosts a business’s competitive edge, and rakes in more sales.
- Some disadvantages of using net payment terms are delayed payments, reduced profit margins, possible non-payment from customers, and a more tedious accounting process.
What Are Net Terms?
Net terms are short- or long-term extensions to a client’s payment deadline. Also called vendor credit, trade credit, or deferred payments, these are usually granted by vendors to clients with limited financial capacity to send full payments on time.
The time frame indicated in the trade credits begins once the customer receives the invoice.
The goal of using net terms on an invoice is to provide flexibility for customers to fulfill their payment obligations and increase the probability that vendors receive the expected payment for their goods and services.
On the other hand, choosing the most suitable net terms will also depend on the items and services offered.
For instance, a contract between a client and an independent contractor stipulates a Net 15 term in invoicing. This means that once the independent contractor completes the services that the client hired them to do and sends the invoice, the latter is given 15 days upon receiving the invoice to pay the contractor’s services in full.
The most typical examples of net terms include Net 15, Net 30, Net 60, and Net 90. There are also other types of net terms, and we’ll discuss them one by one.
A net 30, 60, or 90 payment term means that the payment is due in 30, 60, or 90 daysupon invoice release. In other words, vendors or businesses receive the payment in full after 30 days. Conversely, vendors can choose to extend the net 30 terms into a net 60 or net 90 terms.
In such a setup, the seller receives the payment partially after 30 days and the next installment in the next 60 or 90 days until the customer completes their end of the bargain.
The decision on whether to extend a customer’s payment terms is often built on trust and a certain level of professional relationship between the business and the client.
After all, vendors need assurance that a new customer or business can pay for the items they wish to purchase.
Net 30, 60, and 90 terms are among the most widely used invoice payment terms because they help guarantee more stable cash flow for businesses.
At the same time, the 30- to 90-day allowance is more bearable for a customer’s budget compared to when they have to pay a large amount in one go.
End of the Month Terms (EOM)
End-of-Month Terms (EOM) entail a customer completing payment within a fixed number of days after the 30th or 31st of the month. For instance, if an invoice indicates a Net 15 EOM, the customer must send the full payment within ten days after the last day of the month.
Or, if the vendor uses a Net 30 EOM, the buyer must pay for the goods by the end of the following month.
EOM net terms are more common in the shipping industry since vendors take a lot more time to ship the goods and ensure that the buyer receives the items in good condition.
At the same time, buyers are given enough opportunity to prepare the expected payment for their purchase.
Discount terms typically include a two-part statement. The first part of the statement or term indicates the discount offered, while the second part informs the customer of the days they must send payment and qualify for the discounted price.
Let’s say a business offers a 2/10 net 30 term to a customer. The ‘2’ refers to a 2% discount, while the ‘10’ means that the customer has ten days to pay for the discount.
What if the customer cannot send the payment in full within ten days of purchasing the item? This is where the ‘net 30’ of the sample discount term comes into play.
Since the customer could not use the discounted offer, the ‘Net’ describes the item’s net or original price that the customer must pay within 30 days.
Vendors who want to reduce their collection expenses use net terms with discount offers. By offering discounted prices on top of an extended timeframe to pay their purchase in full, customers are motivated to complete their payment obligations sooner.
What Net Terms Mean For Accounting
Net terms, from an accounting perspective, mean additional work in your invoicing checklist and a more protracted process in managing your business’s finances.
You need to account for every payment term offered to each customer and update your records accordingly, based on whether the customer could meet the terms in their invoice.
It is crucial to identify which invoices are due and which ones still have pending payments. Doing so avoids gaps in your accounting records and prevents charging customers who have already paid their invoices.
You must implement additional steps in your billing process, mainly when reminding customers of their balances before and after the payment due date.
Net terms also mean streamlining your accounting process by automating how you bill or send invoices to customers subscribed to your services regularly or recurrently.
Benefits of Net Terms
Having a clear and concise net-terms agreement can bring specific benefits to your business. These advantages apply whether you run a startup, a mid-sized enterprise, or even a reasonably large corporation.
These benefits include:
#1. Generate More Sales
A steady cash flow is one of the main reasons why using net terms is highly recommended for businesses. Net terms provide flexible, interest-free terms for customers and vendors to settle and secure payments for every transaction.
Net 15, 30, 60, and 90 terms address how some customers may have a limited budget and, therefore, need more leeway in fulfilling payments for their purchases.
As a result, customers can acquire the goods and services they need without worrying about incurring interest or credit.
#2. Competitive Advantage
Customers are keen on assessing whether a business gives them value for their money. They want to get high-quality goods without having to drain their wallets.
That said, offering practicable payment terms like discount terms effectively entices customers to choose you over your competitors.
Providing your customers with choices in how they can pay for goods and services they want shows that you value their convenience and adhere to their needs.
#3. Boosts Customer Acquisition & Retention
In reality, acquiring customers is not always the hardest thing to do—consistently meeting their expectations and ensuring they remain satisfied with your products and services is the trickier part.
When customer needs are underscored or given emphasis, it naturally draws customers to keep supporting a business.
Fostering a synergistic relationship with customers through discounted prices for early payments and extended payment due dates builds a solid foundation for retaining existing customers.
#4. Encourages Client Endorsements
Never underestimate the power of word of mouth, even in this day and age. Happy customers stick with businesses they support. Not only that, they will happily recommend your business to their family, friends, and colleagues.
Moreover, businesses that prioritize customer needs and convenience when helping them settle their payments are often associated with trust.
Trustworthy vendors and businesses attract more business deals, customers, and transactions, which is instrumental in attaining long-term stability.
Disadvantages of Net Terms
Advantages usually come with corresponding disadvantages. Below are the possible drawbacks that your business could face if you incorporate net terms in your invoices and transactions:
#1. Repayment Takes Longer
Since you allow an extended period for your customers to complete their pending payments, you should also expect delays in receiving the payment in full.
Whether you use net 15, net 30, or even net 45 terms, this means waiting an extended time before you fully replenish production and manufacturing costs in your operations.
The effect of prolonged repayment on your operations is not always apparent or immediate. However, it will eventually impact your business if you don’t have any countermeasures and financial contingency plans to regulate your expenses.
#2. Some Clients May Never Pay
Nonpaying clients are the worst nightmares of vendors who offer net payment terms. Imagine offering customers an opportunity to settle their balances, only to discover they cannot fulfill their obligations through to the end.
Clients with a history of habitually paying late tend to make expensive purchases because they see the extended due date as an excuse to delay sending their payment.
This is not to say that all or most clients end up not fulfilling their payment responsibilities, but it is still a possibility that you must acknowledge.
It is crucial to send follow-up reminders, issue an overdue invoice letter, or even seek legal action in case incidents of non-payment escalate beyond the payment deadline.
On the other hand, if late payments and nonpayments are pretty standard despite offering discounts and net terms, then there might be an issue with your collection policies. Also, you might not enforce a stringent review process for your customer’s credit history.
#3. Accounting Becomes More Tedious
Net terms entail careful record-keeping to guarantee you don’t miss out on delayed payments or notoriously non-compliant customers.
Keeping your accounting process updated and aligned with any updates on your customer’s credit, accounts, or balances is necessary to prevent your money from going down the drain.
An effective way to minimize invoicing errors and avoid invoice disputes is to organize your records and segregate clients with pending payments from those with extended payment dues and discounted purchase offers.
You need to have a large enough workforce to handle the additional accounting work. Otherwise, you will likely experience strains in your cash flow and mix-ups in following up on pending customer payments.
#4. Reduced Profit Margin
When you offer discounts to customers, it leads to reduced profits for your business. Understandably, discounted prices are effective in enticing customers to purchase more. But, if paired with net terms, it may pose a higher risk to your profit margin.
Ideally, combining net terms with discount offers is best if you have a reasonably stable or sizable gross margin because you have a safety net to sustain your business and balance your costs.
In contrast, discount and net terms are not the best strategies to boost sales and customer retention if your profit margin is lacking.
What Kind of Businesses Offer Net Terms
All businesses can use net-term payments, but there are select types of companies where discounted prices and extended payment deadlines work best.
These businesses are:
#1. B2B Businesses
In a B2B or business-to-business setup, businesses offer services to fellow companies and organizations. A traditional exchange of services and payment in a regular transaction may only work sometimes.
For instance, a business specializes in outsourcing digital marketing services to other companies internationally.
By offering net payment terms on client invoices, the business offering the service and their client can meet halfway in completing the transaction. It is also easier for the company to organize its accounting records and make the necessary adjustments while waiting for the client to send payment.
#2. Freelance Businesses
Freelancers offer their services and expertise in an unconventional setup and thus give more room for net payment terms to different clients.Net terms also help freelancers charge the right amount for their services. For instance, photographers, web designers, virtual assistants, and writers set a fixed schedule that their clients must follow for freelancers to secure payments for their services.
Since suppliers sell goods and raw materials to business owners in bulk, they set their products at a reasonably high price. They also provide customers with net terms wholesale, or the gross amount of the order minus the shipping charges, for transparency.
However, sending the full payment in one go may only be possible for some, especially if the client runs a startup or a small business.
Suppliers and clients must agree on a set number of days in the form of net payment terms to settle the transaction.
In some instances, the client may order the products periodically, and in return, the supplier provides business owners with 30 to 90 days, depending on which one works best, to pay their order in full.
How to Choose the Right Net Terms Payment Option For Your Business
One of the reasons why some businesses experience more disadvantages than advantages while using net terms is that they need more careful planning and consideration.
The following are crucial factors to consider before choosing a suitable net-term payment option for your business:
#1. Analyze Your Industry
You can still offer net terms to your customers even if you are not a freelancer or if you are not in the business of catering to other companies or supplying products and raw materials.
The key is to weigh the risks and advantages of using net terms for your business. Let’s say you offer hospitality services or work in retail. A net term of up to 30 days would not be ideal because you could provide the services and products quickly.
A client who booked a hotel reservation may pay in advance or settle their balances by the time they check out of the hotel. Similarly, if a customer purchases items in a retail store, that means they have the means to pay for the item in full in real time.
Meanwhile, if your services require a specific amount of time and workforce to complete customer orders, payment terms of up to 90 days are suitable. This is especially true if you must ship a client’s order or acquire resource materials to complete the item or service.
#2. Consider Your Clients’ History
It is best to offer net terms to customers who have established trust and familiarity with vendors. Entrusting flexible payment terms to new customers risks incurring unpaid invoices or missing payment deadlines.
Aside from the fact that you need to learn the customer better to understand the payment arrangements that suit them best, you are also clueless about their credit history.
Offering discounts and net terms to customers with low credit scores and notorious late payers will likely leave your business with a heavy financial burden in the long run.
Make it a point to scrutinize your customers’ purchasing habits and credit history to ensure you offer buying incentives to the most deserving clients.
#3. Check Your Cash Flow
Check your operational costs, accrued expenses, and potential profit within a specific period.
Does your business still have a sufficient financial safety net? If not, it would be best to wait until your cash flow stabilizes before considering net terms and discount incentives for your customers.
While the goal of using net terms is to encourage and incentivize customers to pay on time, it should not be done at the expense of your business’s financial security.
#4. Consider The Invoice Size
Bulk orders and international purchases are usually compatible with net 15 to 90 payment terms.
The extended number of days is ideal, especially since bulk orders and purchases that entail international shipment require extra work and requirements to ensure fulfillment of the client’s orders.
The invoice size will also depend on the type of service or goods purchased.
If you accept net 0 payment terms or cash on delivery (COD) payment, then your customers can pay the order in full upon receipt of the items without incurring any interest or qualifying for any discounts.
The bottom line is to align your net terms with the final amount charged to your clients. If the price is quite expensive and cannot be easily settled in a single payment, then that’s when you offer net terms.
But if the price is reasonably manageable and can be settled fairly quickly, a net payment term may not be as necessary.
Net terms are an excellent way to meet customers’ needs and help them foster trust and satisfaction with your services. At the same time, it is essential to understand that net payment terms come with certain risks and compromises on your part.
Ensure that you have a safety net ready in case of delayed payments and delinquent customers. Update your net terms as needed to consistently address changing customer expectations and maintain a steady stream of repeat customer purchases.
In this manner, you effectively minimize outstanding payments and avoid facing other possible pitfalls in your business.