Determining Payment Terms

Define Payment Terms: Why It’s Important for Small Businesses

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There are a lot of confusing aspects to an invoice that small business owners often ask us for clarification about. One of the most common questions we get asked is how do I determine what my payment terms should be? If you’ve found yourself pondering this question as well, don’t fret! We’ve got your back.  

Determining Payment Terms

What are Payment Terms?

Before we get started on how to determine a fair payment term, let’s first take a look at what a payment term is what are some common payment terms that business owners use. A payment term is essentially a term on the invoice that specifies when the payment of said invoice is due. This usually comes in the format of a “net-x” term. The most common payment terms that you’ll typically see on an invoice are “net-30”, “net-45”, “net-60”, or “due on receipt”.

What To Consider Before Setting Your Payment Term

Seems simple enough right? But before you jump to decide what payment term you want to use, let’s chat about some factors to consider when setting your payment term.

Consider Your Cash Flow

Every small business has its own expenses to worry about. Expenses like rent, utilities, materials, equipment, payroll…the list goes on! To be able to cover your expenses on time, you’ll need to consider this outflow when looking at setting your payment term. What are the terms of your bills? Can you prioritize them by due date? You need to make sure the money’s there when it comes time to pay the bills so you can definitely set your payment terms to your benefit!

What’s Your Industry Standard?

Payment terms do vary if you’re a tech consultant vs. if you’re a builder or contractor. For a builder or other type of labor-based contractor, it’s totally normal for you to whip out your phone and send an invoice that’s due on receipt immediately after your job. Compared to a tech consultant, who might do monthly work for a client on a retainer, the payment term should be quite different! The point is, get a sense of what others are doing in your industry. If you skew too far in either direction, it might cause confusion with your customer!

Align Customer Expectations

To avoid any confusion or conflicts later on, the best way to address payment terms is up front and within your agreement. Bring up payment terms once you’ve agreed on a scope of work so that your client knows exactly what to expect.

Related: You’re Losing Money By Not Using These 4 Invoice Management Techniques

Be Fair

If your terms are, say, 30 days and a client doesn’t pay within that timeframe, evaluate it on a case basis. Are they a new client? Because if so, grilling them the day after payment was due might not help the long-term relationship. If it becomes a trend though, that’s a different story—a story that likely ends with you not working for them. Again, this is where codifying a process in your agreement can help. Spell out what happens if a payment is late, when the customer will be notified, and when work will cease if payment is still not received.

How Do Slow Payments Impact Your Small Business?

Before we dive into some actionable tips, it’s important to know just how much slow payments are affecting small business owners. Although your client being late a few times might seem insignificant at first, but if it becomes a habit and something that’s happening with multiple clients, it can lead to huge negative impacts on your business. According to a survey by Fundbox, some of these issues are:

Inability to Hire

25% of small business owners across the US chose not to hire new employees to allocate efforts on receiving late payments.

Pay Cuts for Business Owners

79% of business owners cut paying themselves because there is no late fee for paying themselves late, as compared to other business expenses like supplies, rent, and utilities, for example.

No New Equipment to Scale

23% of business owners can’t afford new equipment due to a lack of capital. This directly affects their ability to work with bigger customers or move into new markets.

Saying Bye to Marketing

20% of small business owners cut their marketing and growth efforts due to slow or unpaid invoices.

Defining Invoice Payment Terms: How To Improve Your Cash Flow

Although those previous stats may be a shock to some, these issues can totally be avoided! We want to end off this article with some actionable best practices for you to implement right away to speed up your upcoming invoice payments!

Spell Out Invoice Payment Terms Right Away

As we mentioned earlier in our considerations when determining your payment terms, it’s important to let your client know up front how much time they have to pay the invoice. When you clarify this point right away, you avoid any delayed payments caused by confusion or other simple reasons like they just didn’t see the payment term!

Timing Is Everything

Typically, payment expectations can be anywhere from 30 days to 90 days. The default that most businesses start with is a net-30—or 30 days for your client to pay. If you need to get paid within a specific timeframe, or if your client is a small business that also needs some leeway with their payments, it’s important to have an open discussion with them to find a solution that works for both of you.

Incentivize and Penalize

If clients are consistently paying late, it’s important for the growth of your business to know when to draw the line. Consider applying interest to late invoices, especially if your business’s cash flow needs it. Another common method is actually to positively reinforce the importance of following a quicker payment term. You can incentivize your clients with a small discount (5-10%) if they pay the invoice within 5 business days of issue.

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