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.
Summary
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:
- 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.
What to consider before negotiating 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 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.
For more information on cash flow management, read our articles: How to protect your cash flow and How to make cash flow forecast.
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:
- 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.
“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 payment, 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.
- 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 & 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.
Allianz Trade in Malaysia
We’re global leader in trade credit insurance and a recognised specialist in the areas of surety, collections, structured trade credit and political risk.
Our passion is to give you the confidence to trade and get paid, so you can move your business forward, whatever your goal. Let’s take control of tomorrow, together.
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