If you run a business, you'll need to know payment terms. 

They're basically the rules you set for your customers on how, when, and by what method they need to pay you for a transaction.

Typically, you'll include them on your invoices, clearly outlining the total amount owed, the due date, accepted payment methods, and any late fees or penalties.

While new technologies like payment gateway software, mobile payments, and digital wallets make it easier for you and your customers to settle bills, traditional methods such as checks, wire transfers, and debit or credit cards are still widely used.

To ensure a smooth transaction, you must understand the various types of payment agreements and the challenges you and your customers might face in processing payments. This will also help you decide on the type of payment processing software you need for your business. 

Importance of invoice payment terms

Imagine you're the owner of a small business, and you've just secured a significant order from a new customer. Excited about the opportunity, you promptly start fulfilling the order.

But despite delivering your end of the deal, there's no sign of payment from your customer as days turn into weeks. Meanwhile, you find yourself dipping into your own funds to cover expenses, from operational costs to payroll.

The lack of agreed-upon payment terms leaves you in a precarious position; this is exactly why you need to have payment terms on your bill. They are like the traffic signals of your business finances and keep things moving smoothly by:

• Setting clear expectations: No more he-said-she-said about due dates and amounts.
• Predicting cash flow: Knowing when money hits your bank account helps you plan for expenses and growth.
• Encouraging prompt payments: Clear terms nudge clients to pay on time, keeping your cash flow healthy.
• Building trust: Transparent communication about payment shows you're professional and organized.

Who decides the terms of payment?

Businesses, aka the seller, typically decide the payment terms. They'll outline these terms on the invoice sent to the buyer. There can be some flexibility, though. Businesses with strong bargaining power or established industry standards might have more control over their preferred terms. Sometimes, negotiation with the buyer might occur, especially for high-value orders.

Types of payment terms

There are different payment terms you’ll see once you start doing business. But  some are far more common than others, which you should be familiar with:

• Immediate payment requires the buyer to make payment instantly upon receipt of the goods or services or invoice issuance. This term is often used interchangeably with “cash on delivery” or “payable on receipt.”  While the term “cash” may be confusing (since it’s not the only accepted payment method), payors can also use checks, credit or debit cards, and wire transfers.
• Net 7, Net 10, Net 15, Net 60, Net 90, Net xx, etc., indicate the number of days customers must pay an invoice in full since the invoice date. The word “net” means the total amount paid after discounts. There are many variations of this type of payment term.
• Net 30, end of the month (EOM), means the payment is due by the end of the month following the invoice date.  This can be useful if your billing cycle doesn't align perfectly with calendar months.

Sometimes, companies agree to make exceptions to their standard payment terms and divide or combine payments. Below are some of the most common types of such payment terms:

• Prepayments or advance billing occurs when both parties agree that the payor will pay a percentage of the value of goods or services before they are delivered.  This reduces the risk of losing money. 
• Discounts for early payments encourage customers to pay before the due date. For instance, “net 30 5/10” means a customer has 30 days to pay in full but will receive a 5 percent discount if the invoice is paid in 10 days. The discount won’t be applied if the payment is made later than that date.
• Recurring payments occur on a regular basis, such as monthly or quarterly, like your monthly Netflix subscription. This payment type is usually processed automatically, and the amount is the same every time. Recurring payments are canceled when the business relationship between the payor and the payee ends.
• Partial payments refer to the option to pay an invoice in multiple installments. The difference between partial and recurring payments is that partial payments are only processed during a predefined period. For instance, a piece of equipment that costs $100,000 can be paid in five quarterly installments of $20,000. Partial payments are usually combined with prepayments.  In the case above, the customer may pay 20 percent ($20,000) in advance and the remainder in four monthly installments of $20,000.
• Consolidated payments help companies pay multiple invoices at the same time. Since banks usually charge companies to process payments like wire transfers, it makes sense for businesses to try to avoid making too many payments.
• Progress Payments are common for lengthy or expensive projects in industries like construction. The total payment is divided into installments tied to specific milestones. For instance, you might receive 50% upfront, 25% upon completion of a key phase, and the remaining 25% upon project finalization.

When shipping internationally, payment terms become even more crucial due to factors like distance, currency fluctuations, and potential trust concerns. Here's a breakdown of some key payment terms to consider:

• Letter of credit (LOC) is most commonly used in international trade. It is a guarantee issued by a bank on behalf of the buyer. It assures the seller they will receive payment, even if the buyer defaults. This reduces the risk for the seller in international transactions where trust might not be fully established.
• Documentary collection involves the exchange of shipping documents for payment via the banks of buyers and sellers. The seller's bank collects the payment in exchange for shipping documents from the buyer's bank. This document exchange can happen as a "document against payment" (D/P) or "document against acceptance" (D/A).
• Open account is when the seller ships the goods or provides the services and invoices the buyer, who is then expected to pay later, typically within agreed-upon terms (e.g., Net 30). It carries high risk for the seller and is only suitable for established, trustworthy customers with a proven track record of on-time payments.
• Consignment allows the seller to retain ownership of the goods until they are sold by the purchaser, who then pays the seller a predetermined percentage of the sale price.

The most accepted payment methods

It's important to mention payment methods in your invoice as part of the terms of payment. This clarifies options for clients, promotes faster payments, and projects a professional image. Here are the most common payment methods available for different businesses. 

For online businesses:

• Credit/debit cards
• Digital wallets (Apple Pay, Google Pay, Samsung Pay)
• Online payment gateways (PayPal, Stripe, Authorize.Net)
• Cryptocurrency (Bitcoin, Ethereum) (Emerging)

For B2B transactions:

• ACH transfer (EFT)
• Wire transfer
• Checks
• Payment cards (corporate credit cards)

For In-Person Transactions:

• Cash
• Debit/Credit cards
• Mobile wallets
• Point-of-sale (POS) systems

All these types of payments are processed through national and international electronic payment networks such as the ACH Network in the United States or the PE-ACH (pan-European automated clearing house). These networks are based on the concept of a clearing house — a financial institution that facilitates the exchange of payments, securities, and derivatives. 

Essential payment terms on invoice

A well-crafted invoice with terms of payment is more than just a bill; it's a clear communication tool that ensures you and your clients are on the same page regarding payment.  Essential payment terms for any invoice include: 

• Invoice date: The date the invoice was issued.
• Invoice number: A unique identifier to each invoice for easy reference and tracking.
• Total invoice amount due: The total amount owed by the client.
• Payment due date: the deadline for full payment (e.g., "net 30: payment due 30 days after invoice date").
• Accepted payment methods: e.g., cash, credit card,  bank transfers, digital wallets.
• Payment plan details : the installment amount and frequency of payment for large projects or clients facing cash flow challenges. . 
• Late payment policy: Any late fees or interest charges. 
• Dispute contact information: Contact details for a designated person to address any questions or disputes regarding the invoice.
  
  Source: FreshBooks

4 challenges with payment terms

When managing payments, companies face many challenges and threats that can have a significant financial impact on both payors and payees. Businesses need to be careful to avoid fraud and errors at all stages of the payment process, from invoicing to making payments to collecting payments.

1. Fraud identification and protection

Electronic and digital payments are convenient but may expose companies and their customers to fraud. While banks use advanced technology to prevent fraud, companies don't always have big budgets and tend to rely on the technology provided by e-commerce platforms.

Unfortunately, fraudsters can be very creative and find all kinds of ways to trick merchants and their customers. Here are some of the most common.

• Friendly fraud refers to attempts by buyers to get a refund on goods they bought online, by pretending they never received the items or that they returned them. Some people may also claim their credit cards have been compromised and they didn’t make the purchase.

• Stolen data is the result of individuals bypassing security systems through hacking or data breaches to access sensitive personal information. This information is used by hackers or sold on the dark web.

• Fake online stores are created to get credit card and other sensitive information from consumers. Some fake online stores can be easily identified when they offer promotions that seem too good to be true, or when they provide no details about the company that manages the store.

2. Foreign Currency

Globalization and the internet have enabled businesses to sell products (and sometimes services) all over the world. This isn’t an issue when a global company sells in local currency and its customers pay in the same medium of exchange. Things get more complicated when a supplier provides goods in one currency, such as USD, but its buyers hail from all over the world. In this case, buyers will need to buy USD to pay the supplier. Depending on the exchange rate and its fluctuations, the payment may not be equal to the value of the goods or services purchased.

For instance, a Canadian company that buys products or services worth $1,000 in the U.S.needs to buy USD to pay the invoice. If the exchange rate between U.S. and Canadian dollars changes between the invoice date and the payment date, the company may pay more or less than what it would have paid on the invoice date. In the example below, a buyer that needs to pay a USD $1,000 invoice will pay CAD $10 more if the exchange rate goes up, or CAD $30 less if the rate goes down.

Invoice amount: $1,000 USD

Exchange rate and amount due as of invoice date: 1.35 ($1,350 CAD)

Exchange rate and amount due as of payment date:

1.36 ($1,360 CAD)

1.32 ($1,320 CAD)

3. “Pay to” vs. “ship to” vs. “bill to”

Large enterprises and groups of companies often have very complicated processes for managing payments. The business entity that purchases goods or services might not be the one that makes the payments. Furthermore, separate entities can be invoiced by different suppliers and the parent company can consolidate all invoices to process payments.

It is therefore vital for the company to clearly define which business entity is responsible for what type of purchasing, invoicing, receiving and payment.

4. Collections

Since not all customers pay on time despite clear payment terms, companies need to do their best to collect past-due invoices. One way to collect debt is dunning, by which companies send letters to remind customers they owe money. Businesses may also send interest invoices to penalize bad debtors by applying a percentage to the amount of the invoice.

When everything else fails, companies can use debt collection agencies to collect the money on their behalf. Another option is factoring, when companies sell their accounts receivable to third parties that become responsible for collecting the payments. The difference between debt collection and factoring is that the former is a service delivered for a fee, while the latter is a transfer of debt collection responsibility between two companies. Factoring can, therefore, be more expensive for a business if it sells its accounts receivables at a discount.

Get paid on time, every time

To manage payments efficiently despite these challenges, it is crucial to use software that process payments and related transactions like invoice management software and billing software. Along with,  establishing clear and well-defined terms can ensure timely payments, minimize confusion, and foster stronger relationships with your customers. So, stop chasing payments and start getting paid on time. 

Want more? Explore different payment software that can make your job to get payments easy.   

This article was published in 2019 and has been updated with new information.