How great would it be to have three or four months to pay your vendors?
As amazing as that sounds, it’s not the reality for many small business owners. Instead of enjoying extended payment terms with your suppliers, you’re usually the one waiting for payment for your goods or services. It’s not fair, right?
Besides fairness, longer payment terms can lead to long-term, damaging results – especially for a small business. Luckily, there are things that you can do about it, even if you’re not a large company.
What Are Payment Terms?
Both buyers and sellers have expectations of each other when they conduct business. Payment terms can help avoid any potential misunderstandings and disagreements between the two parties.
Payment terms outline when payment is due on a sale, and every business can set its own. For example:
Cash on Delivery (COD) means that the seller expects payment as soon as the buyer receives their purchase.
Net15/30/45/90 indicates that payment is expected a set number of days from the invoice date.
Other common options include:
2/10 Net 30: Provide payment within ten days to receive a two percent discount.
End of Month (EOM): Payment’s due at the end of the calendar month.
15 Month Following Invoice (MFI): Payment’s due on the 15th of the month following the invoice date.
Payment terms also include the cost of the product or service, the form of delivery, accepted payment methods, and consequences of late payments. They note any special terms discussed during the sale and sometimes include a discount for early payment.
In best practice, you should decide on payment terms at the start of each new client relationship. The seller typically specifies the terms to the buyer and includes them on an invoice. This is one way to avoid extended payment terms.
Why Are Payment Terms Important?
Having clear payment terms is vital to receiving payments on time. Knowing when to expect payment makes it easier to manage cash flow, which helps with budgeting and planning for the future of the business.
Why Do Companies Have Extended Payment Terms?
Often, large companies have longer payment terms on suppliers but shorter payment terms for customers. They use this as part of their cash management strategy.
When companies receive payments quickly but don’t have to pay their bills quickly, they have more money coming in than going out. Companies can use that time to buy back stock, pay off a larger supplier with stricter payment terms, or invest it internally or externally.
How to Manage Long Payment Periods
Waiting a long time for payment can bring detrimental results – especially to small businesses with their own bills and suppliers to pay. So, how do you deal with it?
Here are three great options:
- Incentivize Early Payment: Implementing early payment discounts can be hard to resist from a customer standpoint. Just be sure that the discount makes business sense and doesn’t take too much from your profit margin.
- Require a Larger Deposit: When you can’t negotiate shorter payment terms, getting partial payment in advance can provide you with some cash flow while you wait.
- Use Invoice Factoring: Selling your invoices to a third party at a discount in return for timely payment can be expensive. But even though you have to pay a percentage, you’ll receive the payment a lot faster.
The Bottom Line
After providing a product or service as promised, you want to get paid. And more often than not, when customers use extended payment terms it gets frustrating. By outlining payment terms, you have a better idea of when to expect payment. This helps you avoid potential misunderstandings and get paid fast, which helps with financial forecasting. If you’re dealing with companies with long payment terms, implement an incentive for timely payments, deposit requirements, or invoice factoring to strengthen your business’ cash flow.
Many small businesses struggle with understanding their financials and not knowing how to use that information to plan for their business. Schedule a consultation and we’ll help you understand your finances and choose the best payment terms to manage your cash flow well.