What are net terms?
Net terms are conditions that define payment terms. Often net terms provide a grace period before an invoice is due. Some companies may offer a discount for customers who choose to pay their bill before the due date.
What does net 30/60/90 terms mean?
Net 30/60/90 is the number of days an invoice is due from its invoice date. Net 30 means the invoice is due in 30 days. Net 90 means the invoice is due in 90 days and so on. The start date can vary by company. Some companies may count the date that an invoice is postmarked (mail delivery) or sent (email). Those details will be made available to the customer so everyone agrees on the invoice terms.
The net terms a company chooses are largely driven by its industry average. Industry averages vary across industries. Some may have net 45 terms while others have net 90. Staying around these averages allows a company to remain competitive on its net terms offering. Going with terms that are longer than the average means the company is unnecessarily providing free financing for customers. Terms that are too short means they are too aggressive.
Advantages of offering net terms
There are many reasons to offer net terms, from attracting new customers, growing your business, adding a competitive advantage to building customer loyalty.
Generate more sales
Offering net terms will allow customers to purchase who otherwise wouldn’t. When payments aren’t due immediately, barriers to purchasing go down. Customers are generally more willing to buy on credit. For some customers, they may depend on credit for all of their purchases. Offering net terms ropes in some of these customers.
Gain an advantage over competitors
Your business will have an advantage over competitors who don’t offer net terms. If it is common for an industry to offer net terms, not offering them puts a company at a disadvantage. Customers will gravitate toward the path of least resistance for purchasing anything. This means purchasing on credit.
Companies that offer net terms over those that don’t will likely see more customers come their way.
Build customer loyalty
Giving customers some leeway will help build customer loyalty. Net terms can be a door to new customers. New customers come in for free financing but if the company can provide good customer service, quality products, and competitive pricing on top of net terms, it can build strong loyalty with customers.
Net terms alone may provide some customer loyalty but if competitors are offering the same terms, a company will need to provide an edge (as mentioned above) to keep customers loyal.
Disadvantages of offering net terms
While there are many positives to offering net terms, there are a few things to be aware of. Your billing cycle will become longer, some customers will not pay at all, and there is more overhead. But for many businesses, the advantages outweigh the disadvantages.
Customers take longer to pay
Repayment will take longer if you offer net terms. The payment cycle will extend, and your operations will need to change to accommodate a more extended payment cycle. This change will affect your working capital, as well. At first, working capital may significantly decrease, but once the payment cycle becomes routine, working capital should go back to previous levels.
New terms may need to be negotiated with suppliers since working capital may not initially be available. As your payment terms get extended due to offering net terms, supplier terms, in turn, may need to extend as well. Otherwise, the company may experience a cash flow crunch in which money is not available to meet immediate expenses.
Some customers may not pay at all
Some customers will likely end up not paying at all. It might sound a bit extreme, but nonpayment on net terms is common. However, nonpayments should be a very small percentage of invoiced customers. If there are a lot of nonpayments, this is a sign that credit screening is poor. Customers that should not be paying on credit (because they do not qualify) are being allowed into the company’s credit program.
Nonpaying customers don’t mean it's the end of the line in regards to collecting your money. You can continue to send notices to these customers and eventually start reducing the amount they owe. Some of these customers may pay all or some of the reduced amount. At some point, you might consider hiring a collection agency. Some agency payment arrangements only charge a fee if the agency can collect past due amounts.
Poorer cash flow
Offering net terms means that much of your cash is tied up in inventory while you’re waiting for payment. You’ve sold the product but don’t have any cash to show for it. We alluded to this issue above. Adjusted supplier/vendor terms will handle the gap between making a sale and getting paid. As the company becomes used to the new billing cycle, it should be able to manage supplier/vendor billings without creating a cash flow shortage.
More administrative duties
Processing net terms create more administration than paying upfront. Your accounts receivable (AR) will become more complex. You'll have to keep track of sent invoices, net terms for each customer, discounts, nonpayment, and collections. Much of your AR can be outsourced, which removes virtually all (AR) complexity out of the company and allows you to focus on your core competencies.
Who offers net terms?
It depends on the industry. If most companies within an industry offer net terms, then any new entrants will likely have to do the same to remain competitive. Of course, nothing keeps any business from offering net terms.
Any business that bills by invoice rather than upfront may offer net terms. As previously mentioned, if it is standard in your industry to offer net terms, you basically have no choice but to offer them. If net terms are not standard in your industry, offering them is generally a plus and can help your business grow.
B2B businesses commonly offer net terms to smaller business clients. Most businesses deal on net terms. For B2B businesses, it is common to offer net terms.
Food and materials suppliers commonly offer net terms. Just as you might offer net terms to your customers, suppliers and vendors also offer them for the same reasons — to attract and keep customers. If you are just starting to implement net terms, which will create a longer payment cycle, using suppliers who also offer net terms can help to offset your payment cycle and avoid a cash flow crunch.
Net terms provide a grace period from the invoice date for customers to pay. It is a great way to attract new customers and can help a business grow. Implementing net terms will create a longer billing cycle since customers will no longer pay immediately. Understanding this longer billing cycle and preparing for it, such as using suppliers that offer net terms, will help maintain working capital and avoid a cash flow crunch. Resolve's Advance Pay can help you take care of all the details of offering net terms to your customers.