Credit terms are an agreement between a seller and a buyer which states the amount of payments a buyer will make and when they will be made. These terms list specific details a buyer will need to meet in order to purchase goods on an account. Credit terms are commonly offered to customers that want to make early payments or to “cash-strapped” businesses. This will indicate when payment is due for credit sales, late payment fees, applicable interest, and will also list any discounts.
Credit Term Example
A common credit term for credit sales is: 2%/Net 10, or Net 30. Which means that the total payback amount is due in 30 days, but if a customer pays in 10 days instead of 30, they will get a 2% discount on the balance due. To put it in a real scenario, assume a business sold $5,000 worth of goods. This business offers a credit term of 4%/Net 10, Net 30, meaning you have 30 days to pay back the initial $5,000 amount. However, if the invoice is paid in 10 days (or prior), the balance due of the invoice is reduced by 4%, so balance due is $4,800.
Credit Terms Table
Credit Term Explanation Effective Interest
Net 10 You pay the total in 10 days Not Applicable
Net 30 You pay the total in 30 days Not Applicable
1%/Net 10, Net 30 1% discount if you pay in 10 days, or you can pay the total within 30 days 18.2%
2%/Net 10, Net 60 2% discount if you pay in 10 days, or you can pay the total within 60 days 7.3%
Types of Credit Terms
Cash on Delivery:
(Payable on receipt) When working with these credit terms, the payment must be made at the same time as the product or service is provided or delivered.
When these credit terms are applied, the buyer must pay the entire amount before goods or services are provided.
Payment in Advance:
The seller may request either partial or full payment before providing their services or product.
Payment is completed over a period of time, and the agreed upon amount must be paid on specific dates, or various performance completion, or in progression of checkpoints.
Bill of Exchange:
An agreement made between the buyer and seller to arrange payment at a later date.
Factors Influencing Credit Terms
Factors that may affect credit terms are time, credibility, and interest rate. With time, a buyer and seller agree on a time limit. This will state when a buyer expects payment to be made – these terms are discussed before the transaction is complete. Credibility may also influence credit terms. A company may lend you a specific credit depending on your creditworthiness. This creditworthiness may be determined by your previous payment history and the volume of the transaction. Lastly, interest rate also plays a factor. Sellers may charge interest for the entire payback period or only when payment is overdue, depending on the amount and your seller.
Managing A Credit Term
Since credit terms are determined by the business, they may differ from customer to customer. To manage these relationships and credit terms, many businesses mention the credit terms on the invoice. This may help to keep track of the due date and alert a customer of overdue bills. Another option a business may turn to is setting a credit limit and period for each customer. Based upon factors as mentioned above, a customized credit period and credit limit can help avoid overselling, overdue payments, and managing sales/accounts.