Payment Terms Definition
Payment terms — also referred to as terms of payment — are the conditions that a seller will complete a sale, and the specified period of time the buyer must pay the amount due to complete the transaction. Payment terms can vary depending on contracts and conditions set forth during procurement negotiations. They can include cash in advance, cash on delivery, a deferred payment, or other discounted arrangements.
In accounting, payment terms are the rules imposed to ensure that payments are received within a reasonable period of time. Payment terms also help businesses receive payments on a predictable schedule. When there is a fixed payment schedule, businesses or organizations can create a budget and make financial forecasts so that you prevent any cashflow problems.
Payment terms are typically found on sales invoices delivered to the accounts payable department. Invoices will specify when the purchaser, customer, or client must pay for the goods or services provider by the supplier or vendor; it will have the terms of payment, either standard to the supplier or vendor or as agreed upon during the procurement process.
As businesses of all sizes and industries require regular cashflow to pay their expenses and employees, invoicing is essential to collecting payment for goods and services. However, the invoice is only as strong as the payment terms outlined, as payment terms clearly communicate expectations of payment, preferred payment methods, and consequences for late payments.
Three overarching types of accounting payment terms include:
- Net terms: The full amount, or “net amount”, is due for payment. Typically, there is a number of days specified when the full or net amount is due. For example, net 30 means the full amount must be paid in full 30 days after invoice date.
- Discount terms: A two-part condition, where a discount is given if payment is made within a certain time period specified. For example, 2/10 Net 30 means that a 2% discount is allowed if the net amount is paid within 10 days after invoice date.
- End of month terms (abbreviated to EOM): The payer must issue payment a specified number of days after the end of the months. For example, net 5 EOM means that payment must be issued for the net amount 5 days after the end of the month, regardless of when the invoice is dated.
Below is a detailed listing of common standard payment terms:
|Net monthly account||Payment is due on the last day of the month following when the invoice is dated|
|PIA||Payment in advance|
|Net 7||Payment 7 days after invoice date|
|Net 10||Payment 10 days after invoice date|
|Net 30||Payment 30 days after invoice date|
|Net 60||Payment 60 days after invoice date|
|Net 90||Payment 90 days after invoice date|
|EOM||End of month|
|21 MFI||21st of the month following invoice date|
|1% 10 Net 30||1% discount if payment received within 10 days of invoice date or full payment 30 days after invoice date|
|COD||Cash on delivery|
|Cash account||Account is cash only, no credit granted|
|Bill of exchange||A promise to pay at a later date, usually supported by a bank or other financial collateral|
|CND||Cash next delivery|
|CBS||Cash before shipment|
|CIA||Cash in advance|
|CWO||Cash with order|
|1MD||Monthly credit payment of a full month’s supply|
|2MD||Two months credit payment of a full month’s supply|
|Contra||Payment from the customer offset against the value of supplies purchased from the customer|
|Stage payment||Payment of agreed amounts at different stages|
Payment terms are important because they can help businesses and organizations ensure steady cashflow — ensuring the have adequate cash and to satisfy expenses and obligations. Payment terms can make sure that cash flows in at a predictable rate, thus helping budgeting and forecasting. To set a useful schedule, it is important to set clear expectations and communicate explicitly terms and conditions of payment.
Best practices to write effective invoice payment terms include:
- Clear and polite wording: First, the terms of payment should be clearly communicated and explicitly stated. In addition, it helps to include friendly language that can increase the likelihood of on-time payment (ex. Kindly pay your invoice within 10 days).
- Itemized layout: A detailed description of dates, goods/services, price per unit, and total price can make it clear what the invoice is for and what is being paid, increasing the chance of on-time payment.
- Use terms like days due instead of net: Vague terms like “net” or “due upon receipt” can be confusing and lead to late payments. Try to use clearly understood terms, such as “due in 60 days”.
- Late payment consequences: Invoices should state the penalty for a late payment; this can help ensure on-time payment.
- Short payment terms: If you can negotiation shorter payment terms with clients, it can ensure faster cashflow and adequate working capital for the business.
In addition, the best invoice payment terms are:
- Net 30 – payment 30 days after invoice date
- 2/10 Net 30 – 2% discount is paid 10 days after invoice date; full payment 30 days after invoice date
- EOM – End of month
- 15 MFI – 15th of the month following invoice date
- Upon receipt – payable upon delivery of invoice
Source: Accounting Payment Terms (Accounting Tools)