8 Tips for Setting Your Invoice Payment Terms to Improve Cash Flow
December 15, 2022 |
The C2FO Team
Are you using the right invoice payment terms? Learn how to set effective terms that help ensure prompt payments and steady cash flow.
How your business sets invoice terms can impact your cash flow and, ultimately, your capacity to pay your bills and employee wages, and invest in opportunities to grow. Late invoice payments are a key cause of cash flow issues for small and mid-sized businesses. In fact, nearly half of all B2B invoices in the US are overdue, and almost all B2B businesses in the US (93%) have reported receiving late payments.
Fortunately, you can avoid or reduce late payments by prioritizing your billing processes and setting the right invoice payment terms. At the same time, it is important that your terms help build and maintain good relations with your customers.
In this post, we’ll explore the most common invoice payment terms and suggest nine tips to help you set and negotiate the best terms.
What are invoice payment terms?
Invoice payment terms outline how, when and by what method your customers will provide payment to your business. They are an agreement that covers your expectations for payment, including any late payment penalties if your customer fails to remit payment on time. These terms can help you accurately project and maintain cash flow, and establish financial strategies for your business. Payment terms are an essential part of negotiating a contract, and should maximize how quickly you are paid while minimizing inconveniences for your customers.
What are the most common invoice payment terms?
Payment in advance (PIA): Refers to payments or deposits made in advance. For example, a customer might make a 50% deposit on an order with the balance due on completion of the order.
Due upon receipt: A payment due upon receipt is a payment that customers must make immediately upon receiving the invoice for a transaction.
Net 7, 10, 30, 60, 90: These terms refer to the number of days within which a payment is due. For example, net 30 means that a customer must settle its invoice within 30 days of the date listed on the invoice.
2% 10 net 30: Customers will receive a 2% discount if the invoice is paid within 10 days; otherwise the full amount is due in 30 days. For example, an invoice for $2,000 could be settled for $1,960 if it’s paid within 10 days.
Line of credit pay: Most common among larger corporations, line of credit pay gives the customer the ability to pay its invoices over a period of time, such as monthly or quarterly.
Tips for setting and negotiating invoice payment terms
Choosing the best payment terms for your business is critical because it can help you manage and optimize cash flow. Here are some tips for setting invoice payment terms:
1. Know your company’s cash flow position
Although you should keep customer expectations and industry standards in mind when setting invoice payment terms, your primary concern should be your cash flow needs. Therefore, detailed knowledge of your own cash flow position is a must for negotiating payment terms.
Do your cash reserves allow you to extend trade credit if your customer requests it? Or does your current cash position mean that offering generous payment terms would jeopardize your ability to meet your own financial obligations? The better you know your cash flow position, the better you’ll be able to negotiate terms that work for your business.
2. Assess the customer’s credit
Before entering into any new customer relationship, it is helpful to run a credit check. It is also good practice to ask new customers to complete an account application, with financial and trade references, if applicable. Credit checks with a credit bureau will provide you with an assessment of a company’s creditworthiness. Trade references will give you a further indication of the customer’s trustworthiness and financial state.
This information can help you determine the kind of payment terms or trade credit you are willing to extend. For example, if a customer has a history of late payments, you may decide to ask for the invoice payment in advance or a deposit. If a customer’s credit rating is high, you can be more confident about agreeing to more generous payment terms.
3. Know the standard terms for your industry
Net 30 (payment due within 30 days) is a common standard for many businesses. However, payment terms can vary from one industry to another, so it’s in your best interest to consider what your customer is familiar with. For example, payment terms in the transportation industry range from 30 to 120 days, but in the landscaping industry, net 7 is common. In construction, where delays and change orders can be expected, the average is 90 days or more. In the fashion industry, the norm varies from net 30 to net 60.
If you know that the standard for your industry is net 30, that gives you a baseline for negotiating the best payment terms. Confirming alignment between your payment terms and industry expectations is a good way to ensure you are paid on time while keeping your customers happy.
4. Consider the invoice amount
Another important consideration when determining payment terms is the total amount of invoice. The smaller an invoice is, the less time you want to spend chasing payment on it. If you are invoicing for a small amount like $200 or less, requiring immediate payment (due on receipt) or terms of net 10 may make the most sense.
Larger invoices may merit a longer term so that your customer has more time to come up with the funds. For larger invoices that run to tens of thousands of dollars, terms of net 60 or even net 90 may be appropriate. If you’re working on a large project with a new customer, consider asking for an upfront deposit to reduce the risk of nonpayment. Here again, it depends on how much credit you can afford to extend and how confident you are that the customer will pay on time.
5. Leverage innovative solutions to offer early payment discounts
Early payment discounts offer an incentive to customers to pay you before the invoice due date. These discounts can benefit both parties; the customer saves money and you get paid faster, which helps increase your cash flow. Additionally, using innovative billing tactics like early payment discounts can help you avoid taking on new debt. There are two common methods for early payment discounting: static or dynamic.
With static discounting, customers are typically given just two options: 100% payment at the full term of the invoice or a discounted amount before a fixed date. For example, terms of 2/10 net 30 mean that a company receives a 2% discount if it pays your invoice in full within the first 10 days of the invoice date. In other words, if the customer pays in fewer than 10 days, it gets a 2% discount; otherwise, the full balance is due within 30 days.
Dynamic discounting is a more flexible and modern solution for early payment that gives you the option to view customers’ invoices online and request payment on demand in exchange for a discount. Unlike static discounting, the early payment window doesn’t close at 10 days with dynamic discounting, and the discount isn’t fixed at 2%. Instead, it allows your customers to pay the invoice any time before the agreed term and get a discount that adjusts automatically based on the payment date.
Further, some emerging early payment products enable you to improve cash flow with added perks. For example, C2FO’s CashFlow+™ Card gives you early payment without the expense of a discount, as well as 1% cash back on business purchases.
6. Charge late fees for overdue payments
Consider adding late fees or interest charges to your invoice terms to enforce your payment expectations. A late payment fee is a percentage of the total amount on your invoice charged to the customer according to your payment terms. No company wants to add to its cash flow challenges by paying more than the established rate. Therefore, these fees can serve as an added incentive for customers to pay you sooner or communicate with you if they’re unable to.
Adding a late fee of 1.5% or 2% is standard for overdue payments. However, be sure to indicate this clearly on the invoice and outline the specifics with regard to the agreed time frame to settle the amount due. You can follow up on overdue invoices by sending a friendly payment reminder email to customers. A courteous email reminding the customer of a past-due account sends a message that you’re serious about getting paid. Delinquent accounts can be turned over to a collection agency, but this should be a last resort.
7. Ensure terms are crystal clear and documented
Be sure that all payment details — amount, due dates, discounts, late fees, etc. — are spelled out explicitly in all contracts and invoices. It’s in your best interest to make sure your customers understand and agree to your payment terms. Explain the terms verbally to new customers and include a written description in your initial agreement or correspondence. This will help prevent miscommunication and provide backup documentation should any disputes arise.
Documenting your terms gives you legal standing in case your customer doesn’t pay on time. If your customer ignores your invoices and your attempts to collect, you may need to take legal action to recoup the funds. An invoice is not a legally binding document on its own, so if you don’t have a contract in place, you won’t have any legal ground to stand on.
8. Be flexible and communicate effectively
Above all, be professional and polite, and ensure you keep the lines of communication open with your customers. Obviously, you want customers to pay you on time, but keep in mind you are working with another business, and it may struggle with its own cash flow issues from time to time. For example, if a customer pays late regularly, have a conversation to understand what the circumstances are, and if you’re able, update your terms to reflect what works best for everyone.
Flexibility is key when it comes to negotiating invoice payment terms. However, that doesn’t mean you have to be a pushover. If a customer unilaterally announces an extension of payment terms, don’t be afraid to remind the company of its contractual obligations. After all, you have your own obligations to meet. Continue negotiations in a good-faith effort to come to a mutually satisfactory agreement. Be willing to compromise, but make it clear that nonpayment is unacceptable.
A study by FreshBooks found that invoices that include a “thank you” in the invoice terms get paid almost 90% faster. And 45% of those invoices get paid in seven days or less, while 12% get paid in 14 days or less. Using “please” has a similar result; these invoices get paid 88% faster.
The key to optimizing your cash flow is to get paid as quickly as possible. Your day-to-day operating expenses have to be paid regardless of when you receive payment for your invoices. Invoice payment terms are also important because knowing how much money is going to hit your account, and when, is essential for accurate cash flow projections.
Therefore, it’s critical to understand the ins and outs of invoice payment terms and learn how to set and negotiate yours so that you are more likely to be paid in a timely manner. And, while you may be focused on managing your cash flow to meet your immediate needs, keep in mind that the long-term goal is still to establish lasting relationships with customers you can depend on for repeat business in years to come.