What Are Payment Terms? Definition and Importance for Invoicing

Receiving on-time payments can be critical to a business's success, especially if they use these funds or services to expand and improve their services or products. Creating a term of payment can be important to help businesses receive payments promptly. Understanding how and when to implement this form of compensation can help you better assess your company's revenue and budget. In this article, we discuss what a term of payment form is, what's included in the form and who determines payment terms.

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What is a term of payment?

A term of payment, also sometimes called payment term, is documentation that details how and when your customers pay for your goods or services. Terms of payment set your business's expectations for payment, including when clients pay and what penalties they may receive for missed payments. With this outline, your business can receive payment more easily and make the payment process more transparent to customers.

Related: What Are Net 30 Terms?

Why are payment terms important?

Payment terms are important to understand how much money may be available to a business when deciding on future projects, such as expansion, renovation, new lines of products or advertisement campaigns. These terms can outline regular installment payments, which may help balance needed capital for daily and monthly expenses. Business owners may also experience less stress related to payments and income if they understand more about their monthly cash flow.

Who determines payment terms?

The business owner or head of accounting usually determines the payment terms for customers before they begin any transactions. This is so that customers can clearly understand payment terms and adhere to them accordingly. A business owner may also establish payment terms before opening their business when assessing construction and resource costs.

Related: Accounts Payable: Definition, Skills and Careers

What's included in a term of payment?

In order to develop invoices, business owners may include many elements on their terms of payment sheets, such as cash payments and deadlines. It may also have payment options that provide customers with more time to schedule and make payments. Some items that may appear in a term of payment include:

• Payments in advance (PIA) represent customer payments before they pay the full amount.

• Net days confirm the time after the invoice due date that customers need to make the full payment, such as 15, 30, 60 or 90 days.

• End-of-month payments (EOM) typically define payments for each month instead of paying the amount all at once.

• 21st of the month following invoice (21 MFI) states the customer can pay the listed amount by the closest 21st after the invoice date.

• Cash on delivery (COD) represents any cash payment from the customer once they receive the item.

• Cash next delivery (CND) confirms the amount due on the next delivery if a customer receives multiple items or a series of items.

• Cash before shipment (CBS) can include any amount that the customer pays before the business ships the item to them.

• Cash in advance (CIA) provides customers with an option to pay for items once they return the terms of the payment form.

• Cash with order (CWO) means customers may also pay for the item as soon as they order it.

• One- or two-month debt (1- or 2MD) allows the customer to choose to pay for the item with credit in one or two months.

• Stage payments allow customers to pay for their products during a set time agreed upon with the company.

• Forward dating is when a customer receives an invoice for payment after they receive the order.

• Accumulation discounts give the customer allowances for large orders.

• Partial payment discounts apply to customers who choose to pay for an item or service early.

• A rebate is the repayment that the business can apply to the customer invoice after they've submitted documentation of their order or purchase, typically including a receipt.

• Contra represents a payment from the client, subtracted from the cost of supplies they purchase.

Related: What Is Net 45 Payment? With Invoicing Tips

What to consider when specifying the term of payment

Here are some items to consider when specifying your terms of payment:

Current business goals

When considering how you can structure your terms of payment with customers, think about your current business goals. For example, if you're currently undergoing renovations, setting short payment dates may help you receive supplemental income during the transition. For investments such as expansion, setting short payment dates may also help improve your available capital.

Payment amounts

Consider how much each customer owes to your business. Customers whose accounts have large balances or those who typically purchase in series may provide more capital if they pay in a shorter time frame, as you'll receive more consistent revenue with their constant payments. However, try making your deadlines appropriate for large payments to help maintain customer retention and satisfaction.

Term options

There are multiple options you can give your customers that can be mutually beneficial. Reviewing your term options can help you make the best decision about your current financial situation. Some term options for payment include:

• Prepayment: If you want more capital at the time of the sale, consider asking your customer to pay immediately for a product. If they pay in advance, you can have more money available for current operations.

• Upfront percentage: Upfront percentage payments allow customers to pay a percentage of the full payment immediately, then pay the rest at a later time.

• Installment agreements: If you want more gradual cash flow from a customer, consider giving them the option to pay their debt in equal payments over a period.

Related: A Guide to Payment Due Upon Receipt (With Pros and Cons)

Where to list term of payment on an invoice

On an invoice, you can list your terms of payment in two primary places. One location is underneath the invoice details, next to your billing address. Within the date ranges and terms, you can list your terms of payment according to your predefined parameters. You can also list your term of payment underneath the accepted payment methods section at the bottom of your invoice.