Net Terms Definition
Net terms, short for "payment terms" or "credit terms,” refer to the agreed-upon terms and conditions under which a buyer will pay a seller for goods or services.
These terms outline the payment timeframe and any applicable discounts or penalties for early or late payment.
Net terms are in the format: "Net X," where "X" represents days.
A credit term is used by any company, a small business or a large one.
Net Terms Example
For example:
- Net 30 Terms: The buyer must pay within 30 days of the invoice date. This is a common payment term.
- Net 60 Payment Terms: Payment is due within 60 days.
- Net 45 Term: The payment is expected within 45 days. Newer companies choose this to build business credit.
- Net 90 Terms: The customer must pay within 90 days.
- Net 10 Term or EOM (end of month): Payment is due within 10 days at the month's end.
Companies use invoice payment terms to manage cash flow, negotiate payment conditions, and clearly understand payment timing and payment option.
Some suppliers offer early payment discounts (e.g., "2/10, Net 30 payment terms"). The buyer gets a small discount and pays within specified days.
Note: Net terms include a late fee clause to incentivize timely payments and penalize delays.
First Day of Net Period
Net terms' first day isn't the same as the invoice date; it starts immediately afterwards.
For example, if a company provides a Net 30 Term, the buyer has 30 days from the invoice date to pay the invoice.
The invoice date is used to calculate the net terms payment period. This lets both parties understand when the invoice amount is due.
Understanding the "Net 306090" start is essential for sellers and buyers. Sellers use this information to manage their accounts receivable effectively, forecast cash flow, and enforce payment policies.
Buyers benefit from knowing the exact payment timeline to manage their accounts payable, maintain good supplier relationships, and avoid late payment penalties. As mentioned above, some companies provide an early payment discount to reward timely payment.
Note: Payment method determines how the transaction is completed, such as through bank transfer, credit card, or check.
Net Terms Usage Across Industries
Many industries use net terms:
- Wholesale and Distribution: Net 30 to Net 60
- Manufacturing: Net 30 to Net 60
- Retail: Net 30
- Technology: Net 30 to Net 60
- Construction: Net 30 to Net 90
- Healthcare: Net 30 to Net 60
- Automotive: Net 30
- Telecommunications: Net 30 to Net 60
- Advertising: Net 30 to Net 60
- Energy: Net 30 to Net 60
- Textiles: Net 30 to Net 60
- Apparel: Net 30 to Net 60
- Pharmaceuticals: Net 30 to Net 90
- Professional Services: Net 30 to Net 60
Note: A small business owner depends on net terms to manage cash flow by extending credit.
Net Terms Benefits
Offering trade credit provides several benefits for both buyers and sellers.
- Cash flow management: Net terms allow buyers to manage and forecast cash flow effectively. They have a specified period (Net 30) to pay for goods or services, allowing them to align payments with revenue cycles.
- Relationship building: Buyers and sellers can negotiate net terms to establish mutually agreeable payment conditions, which helps strengthen relationships.
- Early payment incentives: Sellers offer discounts for early payment (e.g., "2/10, Net 30"), providing invoice payment term incentives.
- Predictable revenue: Net terms contribute to a predictable revenue stream for sellers. Clear payment terms help vendors expect payments better and ensure FP&A.
- Reduced need for immediate capital: Buyers can use net terms to access goods or services without immediate capital. This benefits companies that experience cash flow fluctuations.
- Improved efficiency: Standardized payment terms streamline the invoicing and payment process, reducing administrative complexities for buyers and sellers. This provides cost savings and facilitates smoother business operations.
- Competitive advantage: Offering favorable net terms can be advantageous for sellers. Buyers are more inclined to choose suppliers with flexible and helpful payment conditions, contributing to customer loyalty.
- Credit building: Sticking to net terms contributes to a positive credit history for buyers, which is advantageous when getting credit or financing.
Types of Net Terms
There are various other credit terms in addition to the net payment terms specified above (30, 45, 60, and 90 days).
Other Credit Term Types:
- 2/10 NET 30 Payment Term: The buyer gets a 2% discount if they pay within 10 days; otherwise, the net amount is due in 30 days.
- Cash on Delivery (COD): In this case, the buyer pays during delivery or receipt.
- Upfront payment: Some transactions require immediate payment before providing goods or services.
- Stage payments: For large or long-term projects, payments coincide with specific project milestones or stages.
- Open account: This is a credit arrangement in which a client is trusted with a longer payment term without a formal agreement.
- Consignment: In a consignment arrangement, the buyer pays for goods only after they have been sold, reducing the financial risk for the buyer.
When to Use Net Terms
- Competitive advantage: Favorable net terms are an advantage. It brings customers who prefer flexible payment options and differentiate the company from competitors.
- Repeat customers: Using net terms simplifies the transaction process for repeat and long-term customers with a good payment history.
- Bulk or wholesale transactions: These terms benefit buyers from volume discounts or purchasing larger quantities.
- Encouraging early payments: Offering early payment discounts within net terms encourages customers to settle any overdue invoice or partial payment promptly, improving the company's cash flow and customer relationships.
- Government or corporate contract: Net terms are standard in government agencies or large corporations. These payment terms help secure and maintain contracts.
- Selling to startups or small businesses: Startups and small businesses often face cash flow challenges. Offering net terms is a way to support these customers and gain loyal clients with growth.
- Balancing risk and reward: Companies must assess customer creditworthiness when deciding net terms. While offering longer payment terms can attract a company, you must balance this with non-payment risk.
Disadvantages of Offering Net Terms
- Cash flow issues: Allowing customers to defer payments can give rise to a cash flow problem, especially for smaller businesses that rely on steady cash inflow.
- Late and delayed payments: Late payments significantly impact net terms. A delayed payment strains cash flow and leads to financial challenges.
- Increased credit risk: Net terms involve credit risk, as customers can default. Credit risk management and assessment are vital to avoid financial loss.
- Administrative challenges: Managing and tracking payments can be challenging. This is done by adopting accounting software such as an accounts receivable automation solution.
- Reduced revenue: Incorporating early payment discounts within the collection strategy impacts profitability and overall revenue.
- Cash flow inconsistency: Relying on net terms results in inconsistent cash flow and makes meeting financial obligations difficult.
- Invoice factoring: Payment delays result in interest costs if a company finances operations using borrowed funds, such as factoring or loans.
FAQs
How do you use net terms?
You set net terms by agreeing on a payment period with your buyer or supplier and specify days like 30, 60, or 90, within which the invoice must be paid after it's issued.
What are the most common net terms?
The most common net terms are Net 30, Net 60, and Net 90.
What are the net terms of an invoice?
The net terms of an invoice specify the time frame within which payment must be made after the invoice date.
What does net 20 terms mean?
This means the payment is due within 20 days after the invoice date.
