09.20.2024 | Posted by Erik
Understanding AR Payment Terms: What They Are and How to Negotiate Them
Effectively managing cash flow is an imperative for any business—and understanding accounts receivable (AR) payment terms is a big part of that. Payment terms outline when and how your customers will pay for goods or services, and they’re usually agreed upon when signing a new purchase order or contract.
Understanding and negotiating your preferred payment terms ahead of a new client engagement can be incredibly advantageous for your business in the long run. But, like many things in business, terms are not a one-size-fits-all equation—the best arrangement for the business next door may not be the ideal arrangement for your company.
As a provider of accounts receivable management services, we know all the ins and outs of payment terms and how to navigate them. In this article, we’re breaking down some common AR payment terms, explaining how they work, and sharing tips on how to negotiate terms effectively.
The Importance of Negotiating Payment Terms Up Front
Before we dive into the different types of AR payment terms, it’s important to understand that once terms are set in a contract or purchase order, they’re difficult to change. Most companies require that any negotiations happen up front before an invoice is issued. This is especially true for larger companies with rigid terms and structured accounts payable (AP) departments. Once the terms are locked in and passed along to AP, there’s little flexibility to make adjustments.
So, if you’re looking for more favorable payment terms, don’t wait until an invoice is sent. Discuss these details with a new client before accepting a purchase order or contract and involve your credit investigation team in vetting the buyer’s creditworthiness.
Common AR Payment Terms
Let’s take a closer look at some of the most common types of AR payment terms we’ve seen our accounts receivable management services customers use across different industries:
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Due on Receipt
This term requires payment immediately upon receipt of the invoice, usually within one business day. Typically, the invoice isn’t sent until after goods are shipped or services are underway. Due on receipt terms are often used by small companies facing cash flow constraints or businesses that need immediate funds to pay subcontractors or suppliers.
When to use it: Due on receipt is an effective option for smaller businesses with tight cash flow, where delays in payment could disrupt operations.
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Net 10, Net 15, Net 30
Net terms are among the most widely used AR payment terms, specifying the number of days a payment is due after the invoice date. Net 30, for example, means the invoice is due 30 days after it’s issued. Many businesses use Net 30 because it strikes a balance between giving customers time to pay and keeping cash flow steady. Keep in mind that in the apparel sector, extending payment terms beyond 30 days is more common.
When to use it: Net terms work well for businesses with a stable cash flow that can afford to wait a few weeks for payment. For new customers, you may want to start with Net 10 or Net 15 until trust is established, as long as this an accepted practice in your industry.
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Net 60, Net 90, Net 125
These extended payment terms are more common in industries like retail and apparel, where companies may need more time to sell products before paying invoices. Big-box retailers and large anchor stores are known for using terms like Net 90 or even Net 125. While this can strain the cash flow of small, boutique suppliers, if you have a unique product that’s in demand, you might be able to negotiate more favorable terms.
When to use it: Only consider extended terms if the client is critical to your business or offers substantial volume. Be cautious, as Net 60 and beyond can create significant financial strain for smaller suppliers.
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End of Month (EOM) Terms
End of Month (EOM) payment terms allow businesses to extend the due date for payments based on the end of the month in which the invoice is issued, rather than the actual invoice date. While EOM terms can give buyers more flexibility, they could negatively impact liquidity for vendors and should be entered into with caution.
For example, with Net 30 EOM terms, if goods or services are rendered before the 15th of the month, the payment is due 30 days after the end of that same month. If the delivery occurs after the 15th, the payment is due 30 days after the end of the following month. So, if your apparel company delivered your order on October 16, payment would be due at the end of November.
When to use it: EOM terms tend to favor buyers more than vendors, so only agree to these terms if you have the financial flexibility to handle delayed payments.
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Credit Card Terms
With credit card terms, the buyer pays in full before you fulfill the order. This ensures your business is paid up front, reducing the risk of late payments or non-payment.
When to use it: This is an excellent option for businesses that can’t afford any payment delays or are dealing with new or high-risk customers. For example, if your credit investigation team recommends not extending credit to a new account, you can offer them credit card terms instead.
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ACH or Wire in Advance
Similar to credit card terms, ACH or wire payments require the buyer to transfer funds before goods are shipped or services are rendered. This method guarantees payment and speeds up cash flow.
When to use it: Use ACH or wire terms when working with high-risk clients or in industries where quick cash flow is essential.
Negotiation Tips for Payment Terms
While many companies are flexible on payment terms, larger organizations often have more rigid structures. However, most businesses are willing to negotiate up front, as long as the terms align with industry standards. Here are a few tips for negotiating terms effectively:
- Start with a credit investigation: Before negotiating terms, ensure your credit investigation team has reviewed the client’s financial health. This can help you determine whether shorter terms like Net 15 or upfront payments are necessary.
- Leverage your unique offerings: If you’re offering a product or service the buyer really needs, you have more negotiating power. Don’t be afraid to ask for more favorable terms if the buyer is eager to work with you.
- Be willing to compromise: While you may prefer shorter payment terms, being flexible within reason can help maintain relationships and secure long-term partnerships. For instance, offering a Net 30 term instead of Net 15 might win you more business without jeopardizing your cash flow.
What to Do if You Need to Change Payment Terms
Changing payment terms with an existing customer can be a challenge, but it’s not impossible. The key is to have a candid, professional conversation with the buyer and present your case.
Start by asking, “Do we have any flexibility to adjust the payment terms?” If the buyer is a loyal customer, they may be open to renegotiating—especially if you’ve consistently delivered high-quality products or services. Keep in mind, though, that once the invoice reaches the AP department, it’s typically out of the buyer’s hands. That’s why it’s crucial to bring up any changes as soon as possible.
If the customer isn’t creditworthy and you’re concerned about late payments, consider switching to credit card or ACH terms. Your accounts receivable management services provider can help facilitate these changes to ensure a smooth transition.
Payment Terms Are Negotiable, But Timing Is Key
Understanding and negotiating AR payment terms is essential for maintaining healthy cash flow and reducing payment risks. Always negotiate terms up front, involve your credit investigation team, and be proactive about requesting changes when needed. With the right strategy, you can create terms that work for both your business and your customers.