Payment terms: What they are and how they can protect your business

Knowing how to send an invoice correctly is crucial as a business owner, self-employed freelancer, or anyone who handles an operation’s finances. Timely payments keep cash flowing and ensure that you are able to pay bills to keep business running smoothly. 

When starting a business, late payments and outstanding income owed to your business are no laughing matter - there are fast - approaching bills of your own to pay. To make sure your clients pay you properly, it helps to understand common payment terms and how to use them.

• What are payment terms?
• Common payment terms
• Payment term examples
• How to use payment terms
• How to choose the best invoice terms
• How to control payment methods with payment terms
• Payment term tips

What are payment terms?

Payment terms outline how, when, and by what method your customers or clients provide payment to your business. Payment terms are typically associated with invoice payments. 

They are an agreement that sets your expectations for payment, including when the client needs to pay you and the penalties for missing a payment. Having transparent payment terms can help ensure you get paid and makes it easier for your customers to understand your billing process.

Payment term elements

Components of invoicing payment terms typically include:

• Invoice date
• Total invoice amount due
• Payment date 
• Acceptable payment time frame
• Late payment policy
• Stipulations for an advance or deposit
• Payment plan details
• Accepted payment methods

 There are also a few additional factors to include on your invoices, such as:

• Invoice number: This will allow you and the customer to track invoices chronologically. 
• Dispute contact: You will also want to provide your contact information so the customer knows who to contact if there are any issues. 

When are payment terms created and updated?

Payment terms should be created prior to sending out an invoice and should be updated whenever the payment structure changes. For example, whenever you move from a net 30 to a net 15 plan, you should notify customers of the change and update the terms prior to issuing the next invoice. 

Why are payment terms important? 

Payment terms are important because knowing how much money is going to hit your account and when is essential to accurate cash flow projections.

Accurate cash flow projections help you:

• Plan for taxes
• Keep your business running smoothly
• Manage business growth
• Receive payments on time

A clear, professional invoice can help ensure that you and your customers are on the same page once work is complete.

Common invoicing challenges

Invoicing is not as cut and dry as some may assume. There can be payment problems as well as management issues that arise. Common invoicing challenges include:

• Fielding disputes over payment terms 
• Attempting to collect late or delinquent payments
• Managing payments and tracking invoices
• Keeping payments secure

Clear and legally binding payment terms, as well as online invoicing integrations, are some of the ways to help mitigate these issues.

Common payment terms  

Let us review some of the most common words and acronyms that small business owners should be aware of when generating invoices: 

1. PIA: Payment in advance
2. Net 7, 10, 15, 30, 60, or 90: Payment expected within 7, 10, 15, 30, 60, or 90 days after the invoice date
3. EOM: End of month
4. 21 MFI: 21st of the month following invoice date
5. COD: Cash on delivery
6. CND: Cash next delivery
7. CBS: Cash before shipment
8. CIA: Cash in advance
9. CWO: Cash with order
10. 1MD, 2MD: Monthly credit payment of a full month (or two month) supply
11. Stage payments: Set payments over a period of time, agreed upon by the client and seller
12. Forward dating: Invoicing for payment to be made after the customer receives the order
13. Accumulation discounts: Discounts on large orders
14. Partial payment discount: When a seller offers a partial discount due to low cash flow
15. Rebate: Refund sent to the buyer after they have made a purchase
16. Contra: Payment from the client, offset by the cost of supplies purchased

Payment term examples 

To get a better idea of why payment terms are essential to your business’s finances, Let us take a look at an example of a situational experience and a set of payment terms.

Invoice sheet example with labels

As you can see in the image below, the example shows several payment term elements such as business name, invoice amount, and accepted payment methods. There is also space for personalization where you can add a logo and personal message. 

Situational example

Imagine you are about to open a new storefront and you need to purchase $5,000 in equipment. You recently received a large order from a customer and submitted an invoice for $7,000. You estimate that the customer will pay the invoice by the end of the month.

But the customer does not pay on time. As a result, you can not purchase the new equipment you need and you are now paying rent for your storefront, even though you are not conducting any business out of the location. You begin to lose money as a result of the late payment.

Putting together a concise, easy-to-understand invoice will go a long way toward ensuring you receive payments on time. This way, you can afford to keep up business operations and meet your growth goals.

How to use payment terms 

Payment terms are essential when negotiating a contract, and an effective set of payment terms should benefit both parties. They should maximize how quickly your clients pay you and minimize inconvenience for your customer.

To maintain a healthy business, remember that your payment terms should match your business plans.  Align your net payment terms based on your typical sales life-cycle. Discuss payment terms with your clients upfront and always include your payment terms on invoices.

Prepayment 

You can require customers to pay in advance for services. Advance billing can improve your cash flow and reduce the risk of losing money. Getting paid in advance can be a major benefit for businesses—many companies sweeten the deal by offering discounts to customers who pay in full upfront. 

Example: If you have an event photography business, you may want to avoid the risk of cancellation by requiring full payment (or a deposit—see below) before the event takes place. 

50% upfront

You may choose to require a partial payment of 50% of the total cost of a customer’s purchase. Partial payments can provide the working capital you may need to complete a customer’s project. They may also benefit your customers by breaking up their costs into smaller payments. Smaller payments for your customers can benefit your business as well, in the form of increased sales and higher order value.

Example: If you operate a wedding venue, a 50% deposit may also be a worthwhile compromise if a customer is unable or unwilling to pay in full upfront. If you choose these terms, be sure to define when You will receive the remaining 50%.

Installment agreements

You can also choose to accept partial payments, or installments, through payment plans based on project milestones or time. Some companies split up big projects into milestones, and the customer pays upon each milestone. You may base installment agreements on time—every three months, for example—or upon delivering a specific part of the project.

Installment agreements are similar to line of credit payment terms, except they are cash-based.

Example: You may choose to divide the customer’s total cost into a series of smaller monthly payments. Services like After-pay now make this feasible for vendors such as Sunglass Hut, where customers can buy something and pay it off over several months. 

Lines of credit 

Line of credit payment terms offer buyers credit toward products and services. Customers can then repay the balance on the agreed payment schedule. Offering credit through your business comes with some risks, however, as the customer could default. Larger organizations typically use this type of customer financing, as opposed to small businesses.

Example: A construction company that has won a big contract may not have the means to perform the job upfront until payment is received. However, by receiving a line of credit from their creditor (a bank), they can continuously use this credit to complete their project and repay as they receive payment from the customer. 

Immediate payment

Immediate payment, or payment due upon receipt, refers to a transaction for which payment is due as soon as you deliver goods or services. Examples of immediate payment terms include cash on delivery (COD) or payable upon receipt. You may add into the contract that you have the right to repossess goods if the customer does not provide immediate payment.

Example: A pizza delivery company often asks for cash on delivery as soon as the product is received by the customer. 

Net 7, 10, 15, 30, 60, or 90

These terms refer to the number of days in which a payment is due. For instance, net 30 (or n30) means that a buyer must settle their account within 30 days of the date listed on the invoice. Using net 30 terms, if you date your invoice March 9, clients are responsible for submitting payment before April 8.

Choosing net payment terms may inconvenience you as a business owner, as You will have finished the project or delivered the product without receiving income. However, customers may prefer these terms. Try to find a period that works for both you and your client.

Example: Many freelancers work on net 30 terms. This is where their clients only run payroll once a month therefore anything completed in the past month will be paid in the coming 30 days.  

Subscriptions and retainers

Subscription and retainer payment terms require customers to pay regularly, such as monthly or annually. Typically, businesses on retainer agreements issue invoices to clients on a recurring basis. Automating invoicing for recurring payments can help.

Example: Retainers are common with lawyers, for instance, where they require a retainer prior to beginning work and automatically invoice a set amount each month.

Early payment 

You can also provide customers with an incentive to pay early. For example, consider offering a 5% discount if the customer pays the total balance in full before the due date. Early payments are a win-win—customers receive a discount on your goods or services, and You will have enough capital to complete the project.

Example: Early payment benefits can be great for wholesalers, who are looking to (and can afford to) take a small pay cut in order to receive cash flow all at once. 

How to choose the best invoice terms

Choosing your business invoice terms can either offer a strong foundation to your business or set it on unstable footing. There are a few considerations to ponder before setting your terms.

Look at cash flow 

Are you constantly running low on cash toward the end of the month? Or are you having a hard time getting started at the beginning of the month due to lack of money? This is a result of having a cash flow problem. The best invoice terms you may want to consider are the ones that get money in your pocket as soon as possible. 

The following options could be a good fit:

• Pay in full upfront
• Pay 50% upfront
• Ask for installments, where the first is due at the time the order is placed

Take industry standards into account 

Different industries have payment term norms that customers expect. Some quick research could give you greater insight into your industry’s norm. 

Take a wedding vendor and a salon, for example. It is common for wedding vendors to request installments throughout the process of booking because:

• It would be risky to collect a large payment at the end
• A lot of work is required by the vendor upfront
• It is often expensive to plan and coordinate

On the other hand, a hair salon usually offers cash on delivery because:

• It is a lower risk—one nonpayment will not break the business
• Their work involves a few hours, not months
• It can be relatively inexpensive, depending on the service

Review client history 

Do you find yourself chasing down the same client month after month for a payment? It may be time to reevaluate your relationship and payment terms. 

Notoriously late or delinquent clients may need a policy adjustment to a more strict policy that incorporates any of the following: upfront payment, cash on delivery, or at least 50% upfront.

On the flip side, if you work with a client who has a perfect track record, you might consider rewarding their timeliness with an early payment option and discount to continue to strengthen your partnership and build loyalty.

Consider adding late fees and interest terms 

As we mentioned above, incentive (in its many forms) is a great push to get to the finish line. Late fees and interest can be strong motivators to getting your invoices paid on time. Before implementing any new payment terms, they must be made known to your clients. Here are some tips to go about it respectfully:

• Send an email update email to your client list—make sure pertinent dates and details are crystal clear. 
• Add the new policy to all your upcoming invoices in very plain sight (barring contract agreements around payment).
• Give a courtesy call to delinquent clients and remind them of their current balance as well as when and how the new terms will impact them.

Determine invoice size

Small businesses like site-building and web design may undertake a large invoice for a sizable project. To remedy the risk, they will likely ask for a deposit prior to starting. 

As a business owner in this situation, you should:

• Assess the invoice size: Ask yourself if you are confident in assuming that much risk.
• Look at cash flow: Make sure you can afford it if the project falls through.
• Make a decision based on facts: Some longtime clients may feel comfortable asking you to take on such a risk—make your decision based on their payment history and facts, not trust alone.

Solutions for large (but risky) invoices include installments and deposits.

Common payment terms used for smaller (less risky) invoices include net 30 plans or cash on delivery.

How to control payment methods with payment terms

In addition to controlling the timing of your payment, you also have a say in how customers pay you. Include your payment options in your invoice terms. Setting expectations for your preferred payment methods will help ensure you get paid appropriately and avoid confusion later on.

The simplest way to define your payment policies is to make the process as convenient as possible for the customer. For instance, you may be accustomed to receiving physical checks or cash. However, expanding your accepted payment methods will increase the likelihood of on-time payments. Two of the more modern payment methods you might want to consider are smart invoices and credit cards.

Smart invoices

Software like QuickBooks enables customers to pay online anytime with pay-enabled smart invoices. With smart invoices, customers can pay using credit cards, debit cards, and bank transfers.

You can also set up automatic and recurring invoices, which can reduce the guesswork associated with invoicing. If you do not set up recurring invoices, you can email invoices to the customer directly with a link for payment. These features are useful if you have ongoing contracts.

Credit card payments

You might also accept credit card payments. You can request that the client provide you with a credit card number.

Be aware, however, there are fees associated with credit card payments. Some business owners choose to pay the fees themselves, while others opt to pass them along to customers. If you choose the latter, You will want to indicate this in your contract. The contract should clearly explain that You will charge the customer a credit card fee if they elect this payment method.

Payment term tips 

While there is no one-size-fits-all strategy there are payment term tips that can help you get the job done more effectively. These include:

• Defining your terms in a contract
• Invoicing promptly for on-time payments
• Implementing invoicing online

1. Define your terms in a contract 

Helps with: Avoiding payment and payment term disputes

For some industries It is crucial to negotiate your payment terms with your customer before you begin work. Work together to determine the right approach for both sides. Once you come to a consensus, outline your terms in your contract.

Documenting your terms gives you legal standing in case your customer does not pay on time. If you do not receive prompt payment and your customer ignores your invoices past due, you may need to take legal action to recoup the funds. An invoice is not a legal document on its own, so if you do not have a contract in place, you will not have any legal standing.

A contract is also the perfect place to outline any late fees you plan to impose. Will there be EOM fees? How about penalties or fees for nonpayments? A payment agreement contract serves to protect both of you, so It is in your best interest to be thorough. 

2. Invoice promptly for on-time payments

Helps with: Reducing the occurrence of late payments

Create and send an invoice as soon as you complete an order or service. Delays can result in later payments or cash flow interruptions. Cash flow is the underlying financial infrastructure for your company’s operations. Receiving prompt payment from customers allows you to focus on your day-to-day business functions and growth.

Our free invoice generator allows you to produce a professional invoice for your client. QuickBooks can help streamline your invoicing process to ensure on-time payments.

3. Implement online invoicing 

Helps with: Managing payments and tracking invoices

As snail mail becomes a thing of the past, online invoicing has taken the main stage as a more streamlined way of both sending and tracking invoices. For example, QuickBooks invoicing software:

• Allows you to get paid online twice as fast as opposed to paper invoices
• Lets you customize how customers pay by allowing debit, credit, or bank transfers
• Gives alerts whenever the customer views and pays invoices
• Allows you to set up when you want an invoice sent as well as when you want it paid

Invoicing software can help simplify the payment process. all while integrating with your bookkeeping.

4. Make security a priority 

Helps with: Keeping payments secure

Securing invoice payments is also a concern worth noting. It is entirely possible for fraudulent invoices to be sent in your name, causing significant financial losses for both you and your customer. Here are some ways to avoid this issue:

• Send encrypted emails with invoices: This will scramble the plain text into cipher-text, where only a key can be used to decipher the message.
• Enforce multi-stage authentication: This will require multiple steps to open the invoice and request payment be made.

Professional payment with priority 

Setting up an invoicing process with detailed payment terms is an essential part of business accounting. Payment terms make your payments a priority and set expectations for your customers, making client relationships feel more professional and productive.

Once you have the payment terms nailed down, the next step is to think about how you could accept these different payment types, like partial payments or advanced payments.

With QuickBooks Online, you can easily connect with clients, set up payment terms, and collect accounts receivable.