About half of all invoices issued by small businesses are paid at least two weeks late. More often than not, this is because they’re trying to increase their cash flow — but even with good intentions, this doesn’t always bode well.
To reduce late payments, businesses should set manageable expectations around payment terms, including discount terms, end-of-month terms, or net terms, like Net 15, Net 30, Net 60, or Net 90. Whichever you prefer, knowing the ins and outs of payment terms like these can make or break your business.
What are net payment terms — and how do they work?
Net terms are the deferred payment options that create delayed deadlines before an invoice payment is due. When your accountant talks about net terms, they’re most likely referring to one of three types:
- Net 15/30/60/90 represents the time before the invoice is due. So, for example, Net 15 means that the deadline is 15 days after the invoice is sent, and so on.
- Discount terms are net terms in which the business will provide an early payment discount if the invoice is paid before the deadline.
- End-of-month terms indicate that payment is due after a set number of days once the calendar month ends.
The bottom line is that any net term can impact your business’s readily available cash flow. So, when clients miss an invoice date, it can create cash flow problems and affect your ability to pay employees, operating expenses, and supplies that are crucial to your everyday operations.
Why most businesses use Net 15/30/60/90
Out of the three main types of net terms, Net 15/30/60/90 is the standard for many small business owners. These tight due dates are still flexible enough to allow smaller businesses to build trade credit and establish trust through payment plans.
Across many small business owners, Net 30 payment terms are most-used because you can build trust with new clients while reducing cash flow restrictions that come with more extended payment terms (like 60 or 90).
However, you can also choose whatever net terms work best for your business. Landscaping companies, for example, usually request payment within seven days.
But most businesses don’t use low terms like Net 7, 10, 15, or 20 as often: With shorter deadlines, clients are often unable to pay the invoice on time. So it’s usually more manageable for the accounts receivable department to request a 30-day turnaround.
Other net terms — like discount terms — give clients an excellent incentive for on-time payment. For example, discount terms may appear as 2/10 Net 30, which means that the final amount is reduced by 2% if the client pays the invoice in full within the first 10 days of the invoice date.
End-of-month (EOM) terms operate differently: This type specifies that a payment is due after a set number of days once the month ends. So a Net EOM 5 is due five days after the calendar month ends. This can be confusing to keep track of since the due date isn’t as straightforward as Net 30 is, so most small businesses go without using it.
Ultimately, Net 15/30/60/90 is a set term that is easier to implement and understand, thus increasing customer loyalty and the company’s cash flow.
How small businesses can benefit from net terms
Realistic net terms — like 30 or 60 days — allow businesses to receive their payments at an expected time every month.
With more cash flow, you can draw in more consumers and leverage other assets and opportunities, like:
- Paying off debt and expenses
- Investing in new opportunities
- Applying for business funding
- Expanding by hiring more employees
- Upgrading equipment
- Accruing trade credit
- Offering competitive prices
Net 30/60/90 terms have a competitive advantage because small business owners can build their client base with flexible terms while still asking for the full payment within a preferred timeframe.
How net payment terms can cause cash flow problems
Until you receive a payment, your cash flow is tied up in the inventory and services you’ve provided to your clients.
And if your client doesn’t pay on time, the consequences are significant. First, your cash flow suffers immensely, and you’ll need to supplement it in other ways. You could also be late on other payments that need to be addressed, like vendor bills, subscription services, and rent.
Invoice management by hand may also affect a healthy cash flow because you need to remember to log every single incoming and outgoing invoice — which can quickly get problematic due to possibility of errors.
But there is a light at the end of the tunnel: Opting for an automated accounting system can save you time, resources, and cash.
How to choose the right payment terms for your business
Don’t randomly choose net terms because they sound like a good idea — you want to analyze your industry, clients, cash flow, and each invoice’s size first to ensure that you’re selecting terms that will benefit you.
Get affordable invoice management that’s easy to use.
Step #1: Consider your industry
Net 30 terms are standard, but average times differ based on individual sectors:
- Agriculture: Immediate to 3 days
- Auto repair: 30 to 90 days
- Cleaning: Immediate to 14 days
- Construction: 90 days
- Food and beverage: Immediate to 3 days
- Hospitality: Immediate to 3 days
- Landscaping: Immediate to 7 days
- Professional services: 60 to 90 days
- Real estate: Immediate
- Retail: Immediate to 3 days
- Transportation: 30 to 90 days
Take time to research your industry’s net terms to better gauge an appropriate payment period.
Step #2: Check your client’s history
You might want to offer different net terms for each client. For example, if you have a regularly on-time paying customer, you might offer them a Net 60 term instead of a Net 30.
On the other hand, if one client often pays late, you might want to change it to a Net 15 instead of a Net 30. It’s not ideal for your customer, but it will incentivize them to pay on time to avoid late fees.
Step #3: Check your cash flow
Setting net terms based on your average cash flow is a great way to ensure you’ll never be left high and dry if a client has late invoice payments. You can find an appropriate net term with an average period collection formula:
Average Collection Period = (Average Accounts Receivables / Net Credit Sales) * 365 days
Say that your business, Cookies R Us, has an average accounts receivable balance of $10,000, and your net sales are $150,000. Using this formula, you’ll get an average collection period of 24.3 — which means you might want to offer Net 15 to Net 30.
Step #4: Consider the invoice’s size
Now, there’s no need to set a net term for every client and every invoice. You can customize them based on your industry, client’s history, cash flow, and how much you’re owed.
Generally speaking, offering longer net terms for larger payments is appropriate: Doing so shows your client that you understand it’s a hefty payment and you’re willing to work with them without causing stress due to unrealistic deadlines.
Streamline your accounts receivable (AR) today by setting net terms
There are best practices for writing net terms and setting your business up for success. So when you’re onboarding a new client and agreeing to payment terms, be sure to:
- Be clear about deadlines and when the net term begins
- Implement late fees and interest fees for overdue payments
- Offer discount terms, so customers pay early
- Tailor net terms to the individual client
To create a system that works for you and the client, determine net terms before the next invoice goes out — or better yet, opt for an automated billing process so that you can focus on your business’s big picture.
That’s where BILL comes in. With streamlined and automated AR processes, you can stay on top of who owes you what, whether they’re late, automatically apply late fees, and send payment reminders without lifting a finger.
Learn more about BILL’s accounts receivable automation software today.
