[The Power of Payment Terms] Get Customers to Pay You Sooner
2/10, n/30 — What it means, and how it can help your cash flow.
Most small businesses have at least one customer who seems physically unable to pay an invoice on time. The more past-due customers a company has to deal with, the longer it makes their cash conversion cycle (the time it takes to turn inventory into sales, plus the time to convert those sales into cash). If left unchecked, late-paying customers can wreak havoc on a company’s cash flows.
These negative cash flow consequences are intensified for companies with a low-volume, high-price sales mix — since a single invoice makes up a significant portion of their revenue. For example, a company that builds luxury yachts might sell five boats during a year for $20 million each, so just one past-due invoice can bring the business to its knees.
As a general rule, the fewer invoices your business sends out, the more important your payment terms become.
Stating Your Terms
By adding payment terms to your invoices, your customers will have an incentive to pay you sooner. Usually found on the invoice header or footer, payment terms tell the customer two things: how much of a discount they can get by paying within the discount window, and how long until the full invoice amount is due.
Payment terms follow a standard format: [% discount] / [Days in discount period] , n / [Days until full amount is due]
The only piece that doesn’t change is “n”, which stands for “net” and basically means the full invoice amount. The other three pieces of the equation can be customized however you see fit, as shown below:
Customizing Your Payment Terms
You don’t have to offer the same terms to all of your customers. Payment terms aren’t set in stone; you can revise or remove them at any time.
The most effective payment terms are customized to fit your unique circumstances. Let’s say your company just started applying 2/10, n/30 payment terms to your invoices, but you’re worried that offering a 2% discount to your biggest customer will hurt your revenues. By offering a smaller discount of 1/10, n/30 to bigger customers will still encourage them to pay sooner, but without the extra strain on your profit margins.
Key Takeaways
While some companies might prefer a one-size-fits-all approach to payment terms, others would rather customize theirs on an individual customer basis. The possibilities are endless…it’s all about finding what will work best for your business.
By adding payment terms to your company’s invoices, customers will have an incentive to pay you sooner. The faster you can convert customer accounts receivable into cash, the more it will help your cash flow.
