Summary: Most commercial transactions use payment terms, typically referred to as offering “Net 30 – 60 days.” These terms are a form of credit that typically gives clients 30 to 60 days to pay an invoice.
Companies must offer payment terms if they want to remain competitive, especially when bidding for large opportunities. However, offering Net-30 terms can also create financial problems if not done correctly.
This article discusses how to offer payment terms effectively while protecting your cash flow. We cover the following:
- What are net 30 terms?
- Advantages and disadvantages
- Which clients should get terms?
- Payment terms and cash flow problems
- Consider early payment discounts
- Finance invoices with factoring
- Conclusion
1. What are net 30 terms?
Most commercial and government sales are made using payment terms. These terms enable your clients to pay their invoices several weeks after the product/service has been delivered.
The number of days in the terms is negotiable. However, they usually range from 15 to 90 days. The most common payment term length is 30 days. This is typically referred to as “Net-30” terms.
Payment terms are usually noted in the “Net D” format, where D is the number of days extended to the client. For example, 30-day terms are noted on an invoice as “Net 30 Days.” Common terms include:
- Net 30 (paid in 30 days)
- Net 45 (paid in 45 days)
- Net 60 (paid in 60 days)
2. Advantages and disadvantages
Most large clients and government agencies expected to get payment terms. Consequently, you must offer terms if you want to compete for those business opportunities. Companies that offer net 30 terms do so because:
- It’s a feature your clients like
- Helps get repeat business
- Enables you to remain competitive
- Allows you to compete for larger contracts
b) Disadvantages of net 30 accounts
However, offering terms have some drawbacks that you must consider. They add complexity to your business. You will also have to deal with slow payments and other collection issues. More importantly, there is the risk that some clients may default on their invoices. This generates losses and can be a source of financial problems.
Consequently, you must be careful when offering payment terms. You must have a good system to track and collect invoices. Additionally, you should only offer net 30 terms to clients likely to pay on time.
3. Which clients should get terms?
By offering payment terms, you essentially provide a type of credit to your clients. Your team must manage this process carefully and only offer credit terms to companies that pay their invoices on time. Otherwise, you risk bad debt and financial problems.
a) Use business credit reports
Using business credit reports regularly is the easiest and most effective way to minimize potential write-offs and bad debt. These reports enable you to check a prospective client’s business credit and evaluate their risk.
Business credit reports allow you to examine if your prospective client pays their vendors reliably. How promptly your client pays other vendors’ invoices is a good proxy indicator of how promptly they will pay you. Reports also allow you to see if the client faces any adverse situations (e.g., lawsuits) that could affect their ability to pay.
Reports come at different prices and detail levels. At a minimum, simple reports include a suggested credit amount and indicate risk level. Comprehensive reports provide detailed information but are more expensive than summary reports.
Anyone can purchase a commercial credit report. The most well-known providers include Dun and Bradstreet, Experian, Moody’s Analytics, and Ansonia.
b) How to handle large credit requests
A large client purchase order presents an opportunity but also a challenge. Your company will probably need to spend a substantial amount of money to fulfill the contract. Consequently, a late or defaulted payment could seriously impact your company’s finances.
We suggest using multiple business credit reports if you work with large contracts. In our experience, using reports from different bureaus provides a more comprehensive view of your prospective client’s risk profile. This strategy will help you to manage their credit terms more effectively.
4. Why are net-30 accounts a challenge?
Offering payment terms can be a financial challenge for companies of all sizes. This is due to the timing of expenses and revenues. Let’s examine a transaction in more detail.
Typically, companies have to fulfill their purchase orders before they can send the client an invoice. They must pay all fulfillment and business expenses out of their cash reserves. After invoicing, the company still must wait 30 to 60 days to get paid.
a) Do you have a cash reserve?
The situation we described is not a problem for companies with adequate cash reserves. They can pay expenses from their cash reserve while waiting for payment. However, companies without significant cash reserves will risk financial problems.
These companies may be able to handle some cash flow issues by delaying vendor payments. This strategy may work in some cases. In our experience, delaying vendor payments is unsustainable and may create other problems.
There are two ways to handle this situation. We discuss them in the next sections.
5. Leverage early payment discounts
One way to solve cash flow problems due to slow-paying invoices is to give clients an incentive to pay sooner. A common incentive is offering clients a discount for early payment.
Typically, clients get a 2% discount if they pay their invoice within ten days. Otherwise, the client must pay the invoice in full on their usual terms. For example, clients with “2%/10 – net 30” terms only get a 2% discount if they pay within ten days. Otherwise, they must pay the total amount in 30 days.
Discounts are negotiable, so offering the lowest discount your client will accept is to your advantage. Common terms include:
- 1%/10 – net 30
- 1%/10 – net 60
- 2%/10 – net 30
- 2%/10 – net 60
a) Early payment discounts have drawbacks
Keep in mind that discounts are optional, and clients choose when to use them. Consequently, offering discounts doesn’t guarantee improved cash flow.
Many clients stop taking discounts during difficult economic times. This strategy helps them preserve their cash flow. Unfortunately, this is precisely when you need them to pay sooner.
Lastly, some clients may abuse the early discount system. We suggest you offer this benefit only to your best clients, who pay you reliably in 30 days.
6. Finance invoices with factoring
Companies whose cash flow problems are not fixed through early payment discounts should consider financing their invoices with factoring. Factoring enables you to offer payment terms while minimizing their impact on your cash flow.
This solution is available to small businesses, has simple qualification criteria, and can be deployed quickly. Read “What is invoice factoring?” to learn more.
a) How does factoring work?
Factoring is relatively simple and can be implemented by small companies. The transactions are financed through a factoring company.
Factoring companies typically finance transactions in two installments. The first installment provides an 80% to 90% advance on your invoice. It is deposited directly to your bank account soon after submitting the invoice.
The second installment, less a factoring fee, is deposited in your bank account once your client pays the invoice in full. This installment settles the transaction. Read “How does factoring work?” to learn more.
b) Advantages of factoring
Factoring your accounts receivable has several advantages over other financing solutions. Here are some of the most important ones.
i) Offer payment terms with confidence
The most important benefit of using a factoring line is that it enables you to offer net 30 terms while minimizing cash flow problems. This is the main reason why companies use this solution.
ii) Adapts to growing revenues
Factoring lines are determined by the business credit of your clients, the quality of your invoices, and your capabilities. Factoring lines can adapt to growing revenues and provide a platform for growth.
iii) Simple qualification criteria
Factoring lines have simpler qualification requirements than comparable solutions, like lines of credit. They are available to small businesses that can’t meet bank lending requirements.
c) Do you qualify?
Factoring lines have simple qualification requirements. The solution is available to companies of all sizes, including startups. To qualify, companies must:
- Be incorporated (e.g., Inc., LLC, etc.)
- Have good invoicing practices
- Have clients with good commercial credit
- Be free of major problems
- Not have liens or encumbrances
- Have knowledgeable owners
7. Conclusion
Most commercial and government clients only work with vendors that can offer net 30 payment terms. This situation puts companies that can’t offer terms businesses at a disadvantage. They can’t pursue these business opportunities without risking cash flow problems.
There are some possible solutions. Companies with minor financial problems may be able to improve their cash flow by offering early payment discounts. However, this solution has limitations.
Companies with ongoing financial problems should consider using a financing solution like factoring. Invoice factoring enables companies to offer terms, improves cash flow quickly, and has simple qualification criteria.
Need factoring?
We are a leading factoring company and can offer competitive financing packages. For a quote, fill out this form or call (877) 300 3258.