What are payment terms? How to use invoice payment terms to protect your business

As a self-employed freelancer or small business owner, knowing how to send an invoice correctly is crucial. Timely payments keep cash flowing, and money in hand now is worth more than it will be in the future.

Research by QuickBooks found U.S. small business owners had an average of $78,355 in outstanding receivables in 2019. Sending a proper invoice is an important step in ensuring your clients pay you on time. To make sure your clients pay you properly, it helps to understand common payment terms and how to use them.

Let’s review commonly used payment terms and how invoice payment terms can protect your small business.

What are invoice 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.

Components of invoicing payment terms typically include:

• An invoice date
• The total invoice amount due
• The payment date and period of time that your client has to pay the total amount owed
• Stipulations for an advance or deposit
• Payment plan details
• A list of accepted payment methods

There are a few other things that you’ll want to include on your invoice. Including an invoice number will allow you and the customer to track invoices chronologically. You’ll also want to provide your contact information. If there are any disputes, the customer knows who to contact, and you can resolve the problem quickly. You can also indicate where you want the client to send a payment receipt.

Invoices with payment terms outline when your organisation will receive income. Your invoicing system should benefit your company strategically.

Standard payment terms

Before we dive deeper into payment terms, let’s review some of the most common payment terms that small business owners should keep in mind when generating invoices.

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

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.

Research by QuickBooks found:

• 80% of small business owners stress about their company’s cash flow.
• More than half of small business owners with cash flow problems say late customer payments are the primary cause.
• 62% of small business owners don’t know exactly how much money they receive each month.
• 58% of small business owners say they’ve made a poor business decision because they were worried about cash flow.

Accurate cash flow projections help you plan for taxes, keep your business running smoothly, and manage its growth. A clear, professional invoice can help you ensure that clients pay in a timely fashion. Clearly communicating terms of payment helps ensure you and your customers are on the same page before work begins.

Example of how payment terms work

To get a better idea of why payment terms are essential to your business’s finances, let’s take a look at an example:

Imagine you’re about to open a new storefront. 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 doesn’t pay on time. As a result, you can’t purchase the new equipment you need. Now, you’re paying rent for your storefront, even though you’re not conducting any business out of the location. You begin to lose money as a result of the late payment.

This example demonstrates the need for timely invoice payments. Putting together a concise, easy-to-understand invoice will go a long way toward ensuring you receive payments on time. As a result, 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. Payment terms should maximise how quickly your clients pay you and minimise inconvenience for your customer. A good set of payment terms should benefit both parties.

As you start to invoice customers, remember that your payment terms should match your business goals. Selecting appropriate payment terms is an important step toward building and maintaining a healthy business. Always include your payment terms on your invoices, but discuss them with your clients first.

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. If you have a wedding photography business, for instance, you may want to avoid running the risk of cancellation. So you may want your customers to pay in full upfront. Some businesses offer discounts to customers who pay in full upfront.

50% upfront

You may choose to receive a partial payment of 50% of the total cost of a customer’s purchase. Partial payments can provide 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.

A 50% deposit may also be a compromise between businesses and customers when a customer is unable or unwilling to pay in full upfront. That way, both parties take on an equal risk. If you choose these terms, be sure to define when you’ll receive the remaining 50%.

Instalment agreements

You can also choose to accept partial payments through payment plans that break your customer’s payments into smaller instalments. As an example, you may choose to divide the customer’s total cost into a series of smaller monthly payments. Instalment agreements are similar to line-of-credit payment terms, except they’re cash-based.

Some companies split up big projects into milestones, and the customer pays upon each milestone. You may base instalment agreements on time—every three months, for example—or upon delivering a specific part of the project.

Lines of credit

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

Immediate payment (payment due upon receipt)

Immediate payment 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 negotiate into the contract that you can repossess goods if the customer does not provide immediate payment.

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 N/30) 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 9 March, clients are responsible for submitting payment before 8 April.

Choosing net payment terms may inconvenience you as a business owner, as you’ll have expensed the entire project without receiving income. However, customers may prefer these terms. Try to find a period that works for both you and your client.

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.

Early payment

You can 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’ll have enough capital to complete the project.

How to control payment methods with payment terms

In addition to controlling the timing of your payment, you also have a say over 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 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 paper cheques or cash. However, expanding your accepted payment methods will increase the likelihood of on-time payments. Two of the more modern payment methods you’ll want to consider are smart invoices and credit card payments.

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 automated clearing house (ACH) bank transfers.

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

QuickBooks Payments offers a free email and ACH payment merchant service account, and free instant deposits with a QuickBooks Cash business bank account.

Credit card payments

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

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’ll want to indicate this in your contract. The contract should clearly explain that you’ll charge the customer a credit card fee if they elect this payment method.

Common payment term challenges among small businesses

Establishing invoice payment terms is critical to protecting your business financially, but setting up this infrastructure comes with its fair share of challenges. Let’s take a look at some of the hiccups that can arise with invoice terms and how you can avoid them.

Payment security

Although online payments are practically the norm for any shopping experience, not all payment platforms are trustworthy. 

Managing payments and tracking invoices

Depending on your business’s size and structure, you may find it difficult to manage payments and allocate funds to the appropriate divisions within your organisation. The fix? Build an invoicing system with clear payment terms and streamlined workflows.

Unpaid invoices

Unfortunately, unpaid invoices are a common occurrence for small businesses. Setting up detailed payment terms and guidelines for late payment can help ensure your hard work is all worthwhile. While there are options you can pursue when you’re dealing with outstanding payments, like invoice factoring and sending past due payments to collections, good payment terms can go a long way to prevent late payments.

QuickBooks makes it easy to invoice your customers, accept payments, and automate follow-up reminders, so nothing slips through the cracks.

Tips for establishing effective payment terms

1. Define your terms in a contract

It’s 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 doesn’t pay on time. If you don’t 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 don’t have a contract in place, you won’t 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 non-payments? A payment agreement contract serves to protect both of you, so it’s in your best interest to be thorough.

2. Invoice promptly for on-time 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.

Key takeaways

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

Invoice payment terms depend on how your business operates, but standard components include:

• Invoice date
• Payment due
• Payment due date
• Payment options
• Payment process
• Miscellaneous stipulations (i.e., late payment penalties, early payment information, interest invoice)

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

While every care has been taken to ensure the accuracy of the information presented as at 01 May 2023, Intuit is not providing you with professional advice and we recommend you obtain your own professional advice. Intuit is not liable for your use of the information presented.