How to negotiate payment terms with customers?

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 payment terms 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.

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.
• The location of your foreign customers: you might want to assess the local country risks, you can check our country risk ratings and our tips to export.
  

 “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:

• 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 they miss the payment deadline, keep up the dialogue and ensure they understand that you won’t accept non-payment or  unpaid invoice.
• 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 interests 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.

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 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 policy, you will be able to control the financial situation of your company and the long-term management of your client portfolio.