The payment terms on your invoices influence how quickly you get paid, so it’s an important decision for your small business. You have lots of different options, from expecting payment upon receipt to giving customers a certain number of days from the invoice date. It makes sense to collect payment as soon as possible to keep cash flowing into your business bank accounts, but you also want to be mindful of your customers, their ability to pay, and the relationship that keeps them coming back. Consider the options and how they might affect your cash flow before you start sending out invoices for your business.
The most common payment invoice term is net days. In simple terms, net days means the customer has a specified number of days after the invoice date before the payment is due. For example, if you set your terms as net 30, the payment due date is 30 days from the date of the invoice. If your customer doesn’t pay the invoice in full within 30 days, the account is considered past due. If you create an invoice on January 1, the due date is January 30. You don’t have to use net 30 as your payment terms. You can choose any length of time based on how quickly you want customers to pay. Business owners sometimes make the terms as short as a week to as long as three months. The use of net 30 or net 15 for small businesses is most common.
Some businesses give customers a grace period of a few days after the due date before escalating the situation. That grace period can create goodwill between your business and the customer, which can encourage them to use your services again. If your customer doesn’t pay up during that grace period, you may need to send an email reminder or make a phone call. When you use QuickBooks Online, you can set up the software to send out reminders automatically when accounts pass the due date, which saves you time. Charging interest or initiating the collections process may be necessary if the account remains delinquent.
Net Days With Discount
You also have the option to nudge customers toward paying faster by offering a discount for early payments. For example, you might offer a 2% discount for full payment within 15 days on a net 30 payment term. The invoice terms would read “2/15 net 30.” This lets the customer know they can get the discount if they pay within 15 days, but they have the option to wait for 30 days to pay the entire invoice if they need extra time. In this case, you list two payment periods, one for the discount and one for the due date. Another example is “1/10 net 30,” which means the customer gets a 1% discount if they pay within 10 days even though they have 30 days to pay before being delinquent. Explaining those terms for new customers helps them understand when they need to pay.
End of Month
Another option is the end of month approach. The due date for all invoices is the end of the month. Regardless of when you issue the invoice, the payment must be made by the end of the month. It’s a simple solution with no need for calculating due dates since they’re all the same. An invoice issued on January 5 and another invoice issued January 10 would both be due by January 31. This option is used mainly for invoices sent during the beginning of the month to give the client enough time to pay. For example, sending an invoice on January 25 with a due date of January 31 gives the customer very little time to receive the invoice and submit the payment before it’s considered late.
Month Following Invoice
Payment terms can be defined as a specified number of days into the following month. This is similar to having a due date at the end of the month, but it buys your customers a little more time and can be more consistent throughout all invoices. For example, the payment term can be applied to an invoice issued on January 5 as well as January 25. In both cases, the payment term can be defined as 21 MFI, or by the 21st day of February. You can choose the specific date in the following month, but you should make sure it gives clients who receive an invoice at the end of the month enough time to pay.
Cash on Order, Shipment, or Delivery
Consider payment terms that hinge on a certain activity happening. The triggering activity can vary depending on your business and when you want to receive payment. For example, you might require an upfront payment when the customer places the order. Other options are cash on shipment or cash on delivery, which require the payment when the transfer of goods occurs. Both payment terms are unrelated to the issuance of the invoice but rather depend on the activity itself.
Due Upon Receipt Considerations
Some companies set payment terms as due upon receipt. That means the client should pay the bill immediately with no extended period for making the payment. This option doesn’t give customers a chance to use, review, or evaluate the goods prior to payment if the item is shipped with the invoice. All customers must have the funds available immediately, which isn’t always the case on larger bills. Consider offsetting that inconvenience by being more accommodating with payment methods. That might mean accepting credit cards or wire transfers. Keep in mind that those payment options usually come with higher fees. Although this speeds up the collection process, it involves more reconciliations, internal controls, and items to account for. Some customers may not like the expectation of paying immediately, which can affect customer satisfaction and retention.
For your business, receiving payment as soon as possible increases the resources available for your use. It can be a suitable option to increase cash flow to alleviate liquidity problems. And aligning cash flows with revenue earned makes record keeping easier. For example, sales made in January are collected in January; therefore, cash and sales are usually both located in the same financial statement month.
Impact of Software
Accounting software can easily integrate whatever payment term decisions you make. QuickBooks lets you choose default settings, including making all invoices due upon receipt or other payment terms you might choose. You can easily apply the standards to all customers consistently without worrying about accidentally leaving out the terms. You also have the option to override the terms as needed. Your accounting software can add your payment terms to the face of your invoice. Plus, sub-ledgers maintaining accounts receivable balances automatically factor in the new payment terms. If you’re considering introducing new payment terms, you can integrate your software with almost any alteration.
Variables to Consider
When determining if all invoices should be due upon receipt or follow another payment term, analyze the dollar amount of your billings. Smaller projects or invoices are more suitable for expecting quicker payments. Look at previous contracts with vendors; historical limitations may also be in place to prevent changes. Discuss the potential change with major customers before you actually change your payment terms. Give your vendors and customers plenty of notice if you make a change. It’s also a good idea to avoid retroactively applying changes in due periods.
Selecting Payment Term
Business cashflow increases with more stringent payment terms. But expecting clients or vendors to pay up faster may negatively impact customer satisfaction. Price discounts are one way to encourage earlier payment without setting a short payment term. This option does affect your cashflow since you’re giving up a part of the bill to the discount. Your cash balances play a major role in deciding your terms. Ensure you have sufficient cash on hand and projected inflows before agreeing to longer payment terms. Researching your market and industry can also help you adapt your terms to align with similar businesses. For example, longer projects tend to have more lax terms, while product sales can have shorter allowable payment terms.
No matter which payment terms you choose, using an efficient system for sending your invoices helps improve your business cash flow. QuickBooks Online helps you create and send smart invoices that help you get paid 2x faster. Try it free today.