Before we jump into what to consider when determining customer credit terms, make sure you are familiar with what your credit terms should include. You should be laying out everything you expect of the customer for payments in the credit terms, so that there are no surprises later on. When presented to the customer, the credit terms should include:
- The amount of credit extended to the customer
- The time period within which payments must be made by the customer
- Early payment discount terms (if applicable).
- The penalty to be charged if payments are late (if applicable).
- And any other condition of payment.
There is no one single way to define credit terms. Every business, every customer, and every situation is different, but there are some things you should think about. Below are few things to consider when it comes to determining customer credit terms:
1. How long has this customer been a customer? New customers might warrant short terms while those who have been long-time customers may deserve extended terms.
2. What is their payment history? If they have always been on-time with their payments, you would be able to feel comfortable with longer terms. Just be careful that a request for extended terms is not an early warning sign of financial instability.
3. What are your competitors and peers doing? If NET10 is the norm – do you do the same or can you afford to extend to NET20 for a competitive advantage?
4. Do you have cash flow issues? If so, consider reducing terms – especially for smaller, newer, or less established accounts. With shorter terms, you should be getting that money to the bank faster to increase your cash flow.
5. Consider discounts for on-time or early payment? 2/10 NET30 meaning 2% discount if paid in 10 days – otherwise full amount NET30. Considering how much you will spend trying to collect the invoice, especially if it goes beyond terms, offering the discount is usually worth it in the end.
6. Have you tried more creative terms? Some find they sell more that way, especially with larger orders, although this will not work in every situation or for every company.
7. If you have a product that is perishable or becoming obsolete you may want to consider special or extended terms to move it off the shelf.
8. Charge late fees when customers go beyond terms. Be careful here, make sure the customer is well aware of the consequences when they sign the contract, ensure all legalities are taken into consideration, and that you are not chasing customers away with this strategy. If you do try this, stick to your guns and follow through with the consequences if your customers don’t pay on time.
9. What about the terms you have with your vendors? Consider asking your vendors for extended terms to improve the health of your cash flow. For example, If you can get paid in 30 days and take 60 days to pay your vendors, you’ll be much better off and have some wiggle room in case you get into a cash crunch.
Remember, credit terms are not set in stone. You can and should consistently re-evaluate your customer creditworthiness and keep tabs on their financial health and behavior as they continue to work with your organization.