Updated on 23 July 2024
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.
The most important terms of your 'Term of sale' contract are cost, volume, delivery, payment method and date. They have to be crystal clear. In your contract, 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:
Granting your client a trade credit consists in agreeing to defer a flow of cash into your treasury, 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 of complications with a bad payer.
Similarly, it is advisable to study your client's financial situation – for example by running customer credit checks ‒ before negotiating invoice payment terms, in order to assess their ability to pay on time.
The company's financial statements can be used to estimate their 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 also request a credit report, detailing the payment history of your client with other companies. The credit score is a measure of a company’s financial stability and how likely they are to pay on time: the score usually ranges from 1 to 100, 75 being an excellent score.
Some banks and companies offer to produce such credit reports or credit scores.
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 before setting the payment terms: a commercial credit is also based on a relationship of trust.
Other more objective and non-financial elements can be taken into account to evaluate your client’s creditworthiness and negotiate appropriate payment terms:
“Terms of sale” are the basic and most important payment terms of your contract: cost, volume, delivery, payment method and date. They have to be crystal clear.
In your contact, trade credit materialises in 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.
There are several levers you can activate to ensure timely payment:
The last two compensations are often difficult to obtain in case of a customer insolvency. This is why the subscription of a trade credit insurance policy allows you to efficiently cover your trade credit risk.
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, ensure the recurrence of orders and ultimately the solidity of your operational cash flow.
Similarly, in case of unpaid invoices, you need to maintain a good customer relationship and appease the tensions to prevent late payment turning into non-payment.
In conclusion, there is no magic formula to negotiate 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 negotiations. Coupled with a good trade credit insurance, you will be able to control the financial situation of your company and the long-term management of your client portfolio.
