Negotiating payment terms with customers can sometimes be a difficult equation to solve without compromising your financial situation or the concluded deal. A strong analysis of your client's situation, along with the relevant coverage mechanisms, can help you find the sweet spot.

“Terms of sale” are the basic and most important terms of your contract: cost, volume, delivery, payment method and date. They have to be crystal clear.

In your contract, trade credit gets extended as a “line of credit,” which details how payment is scheduled over time. It differs from “payment in advance” (PIA), which involves payment before delivery, or from “cash on delivery” (COD), which means immediate payment upon delivery.

In the case of a line of credit, a client may negotiate a discount for early payment of the invoice or a rebate if payment is made on time. This kind of mechanism can be highly virtuous: it encourages your client to pay quickly, and builds greater loyalty in the long run.

Example. A client is granted a trade credit with terms of “5/10 net 30”: if payment is made within 10 days, the client is offered a 5% discount. If not, the full amount is due within 30 days.

You can also negotiate a partial upfront payment or a deposit as a counterpart to longer payment terms. 

Here is a short glossary of payment terms you should be familiar with before beginning any negotiation:

1MD – You allow your client to pay you a specific amount one month after delivering a full month’s goods or services.

2MD – You allow your client to pay you a specific amount two months after delivering a full month’s goods or services.

5/10 Net 30 – You offer your client a 5% discount if you receive full payment within 10 days, otherwise full payment is due within 30 days.

21 MFI – Payment is due by the 21st of the month after the invoice date.

CBS – You require a down payment before you create and deliver a product.

CIA/PIA – You require full payment (cash in advance or payment in advance) before delivering goods or services.

CND –Most often used with regular deliveries, CND (cash next delivery) means you require payment on the current delivery before the next one is sent.

COD – You expect payment for your goods or services when they are received by your client.

CWO – Similar to CBS, cash-with-order terms mean you expect full payment when your client places an order with you.

Due on Receipt – This term, as well as Cash on Delivery (COD) or Payable on Receipt, means payment is expected when goods or services are delivered.

EOM – You can combine EOM (end of month) with other payment terms, as in Net EOM 10 which indicates that payment is due within 10 days of the end of the month.

Line of credit – You allow a client to pay for your goods or services over time.

Net 7, 10, 15, 30, 60, 90 – Payment is due 7, 10, 15, 30, 60 or 90 days from the invoice date. Net payment terms are used to clarify your payment expectations.

Stage payments – You and your customer agree that they will pay you a specific amount regularly over a specific period of time. 

Before negotiating payment terms and extending trade credit with new or existing customers, you want to do all you can to prevent the possibility of a payment default and its impact on your cash flow. It’s important to define and apply a business credit risk management process that helps you thoroughly understand your cash flow position and estimate a prospective or current client’s creditworthiness.

Granting your client trade credit means agreeing to defer a flow of cash into your company even though the invoice has been signed and the turnover recorded. You must therefore ensure that your cash flow position allows you to do so.

This is why a good analysis of your working capital is essential before negotiating credit terms. The accumulation of trade receivables could reduce your free cash flow and handicap your current operations and investments.

It is also useful to check if your company has sufficient solid financial reserves in case customers are slow to pay or do not pay at all.

Similarly, it is advisable to study your client's financial situation in order to assess their ability to pay on time. By understanding your potential client’s credit risk, you will be better informed about extending trade credit. You can identify the potential for credit risk of a prospective or current client by reviewing data about the company from the local Chamber of Commerce, bank and trade data and the company 10k. This information can be used to estimate solvency in the short and medium term. In particular, you should look at their operating cash flow – the cash generated by current operations – as well as their debt-to-income ratio, compared to their industry’s average.

You can purchase a credit report from the national business credit reporting agencies detailing the payment history of your client with other companies, invoice activity and more. Some banks and companies also offer to produce such credit reports. Business credit reports usually include credit scores. The credit score is a measure of a company’s financial stability and how likely they are to pay on time. The score will typically range from 1 to 100, with a score of 75 or higher considered excellent.

Other more objective and non-financial elements can be taken into account to evaluate your client’s creditworthiness  and negotiate appropriate payment terms:

  • The client's size: A small client is often more risky and costly to manage in relation to the volume of business it represents and its financial resources.
  • The lifespan of the goods: If the product supplied is perishable or has a short shelf-life, its collateral value – which can ultimately serve as a guarantee in the event of non-payment – will decrease rapidly. In which case, short payment terms are preferable.

Beyond financial aspects, it is useful to find out about your client's reputation, the reputation of their bank, their business practices and the background of the company's top managers. Extending commercial trade credit is also based on a relationship of trust.

When developing and negotiating payment terms, your first priority is to ensure that money owed to your business for goods delivered or services provided is paid to you. To ensure a positive cash flow, stipulating price, payment terms and delivery expectations is good business practice with prospects as well as existing clients.

Carefully craft your client contract with specifics detailing delivery and payment conditions. Establish the expectation that the contract is to be signed before products or services are provided. To prohibit the new client from negotiating contract terms, clearly define all your payment terms in your contract:

  • Outline payment due date: Clearly outline your billing schedule. In addition, forego vague references to paying upon receipt. Instead, clearly spell out when your invoices must be paid, such as “payable within 30 days of receipt.” Be sure your invoices indicate the exact date payment is expected.
  • Offer payment motivators: Offering an incentive for early payment is a positive motivator for paying before the due date. If you offer a discount for early payment, clearly define what is considered early (net 20 days instead of 30, for example) and the discount the client can expect.
  • Explain late fee penalties: Head off any expectation that late payments are acceptable by stipulating how much of a penalty fee will be applied and when. Be sure to add that same language to your invoices.

At some point, you will have a customer who starts paying late or who asks you for more time to pay an invoice. Managing payment negotiations to the benefit of your business and retaining a potentially valuable client is a delicate process.

  • Listen before negotiating: If a customer proactively comes to you about a late invoice, or you call to speak to your client about a late invoice, listen to learn about their situation. By doing so , you will diffuse any embarrassment and anger and you can set the stage for negotiation rather than compromise.
  • Offer a payment plan: Be proactive and offer a way for the client to more easily manage their obligation to you. A payment plan can ease their stress and result in you getting paid.
  • Compromise on due dates: If the client asks to extend payment from 30 to 60 days, see if a compromise at 45 days would work. Then, ask if that length of time would make it easier for the client to meet future obligations. If so, recast the contract to conserve the relationship and ensure future cash flow.

Once you’ve negotiated terms, there are several ways you can ensure timely payment:

  • Always make sure you invoice as soon as possible and ask your client to acknowledge receipt. Make a note of the invoice details and follow up with your client as the due date approaches rather than waiting until it’s overdue, particularly with invoices for large amounts. If the client misses the payment deadline, keep up the dialogue and ensure they understand that you won’t accept non-payment.
  • Chase late payment quickly and firmly. You can, for example, establish an automated reminder process to remind clients of their payment obligation.
  • Should the client fail to meet payment deadlines, you may require the payment of penalties and interest on outstanding debt. However, if the client's financial situation has already deteriorated, the penalties will be just as difficult to recover.
  • As a last resort, the client's assets may serve as a backstop guarantee. This guarantee can only be obtained at the end of often long and costly legal proceedings.

Collecting late payment penalties or interest, or recovering assets are often difficult to do in the case of a customer insolvency. When you insure your accounts receivable with trade credit insurance, you can count on being paid even if one of your accounts faces insolvency or is unable to pay.

Behind the technical and financial aspects of negotiating payment terms lies a more comprehensive business strategy. You must ask yourself what kind of relationship you want to build with your customer for the long term.

A loyal and regular client must be rewarded: These accounts make up the basis of what sustains your business, ensuring the recurrence of orders and ultimately the solidity of your operational cash flow. Similarly, in the case of unpaid invoices, you need to maintain a good customer relationship and appease the tensions to prevent late payment turning into non-payment.

There is no magic formula to negotiating the perfect payment terms. But a thorough understanding of your financial situation and that of your client, as well as the definition of a clear business strategy, can help you to lay a sound basis for trade credit terms. Coupled with a good trade credit insurance partner, these steps can help you effectively manage risk and enhance your client portfolio.

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