Payment terms: Types, definitions & examples

As a business owner, having a clear understanding of when you can expect payments for products or services sold can help keep your operations running smoothly. Setting clear payment deadlines helps you make projections and ensure your own bills are paid on time. That’s why creating payment terms with customers and clients—especially if you’re a service-based company—can help provide alignment and a shared understanding of when payment is due.

What you’ll learn:

• Payment terms refer to the specific conditions a buyer and seller agree to that outline when and how the seller will be paid for products or services sold.

• Creating clear payment terms helps provide alignment between your business and clients so you can better predict your company’s cash flow cycle.

• Some common payment terms include cash in advance (CIA), payment in advance (PIA), cash with order (CWO) and cash on delivery (COD). 

• When negotiating payment terms, start by understanding your business’s working capital needs and risk level. You can also consider the customer’s credit history and reputation before finalizing an agreement.

Payment terms are a mutual agreement between a buyer and seller that outlines how and when the buyer will pay the seller for products purchased or services provided. While you typically set the payment terms, as the business owner, the specific details may vary, depending on the working relationship you have with the client or customer. 

Payment terms typically include the invoice amount and date and may also outline details such as:

• How payment is made: Payment terms can lay out the accepted form of payment, including the currency type used for international sales. 

• When payment is made: They can provide a clear timeline for when the seller can expect to receive payment, such as within 60 or 90 days.

• Where payment is made: These terms can specify where payment should be made—such as online, through the mail or at a physical location. 

• Method of billing: Payment terms can also outline invoicing methods like billing in arrears, billing in advance or progress billing.

• Additional stipulations: Other items, such as applicable discounts or late-fee penalties, can also be set in payment terms.

Outlining payment terms is important because they set clear expectations for when your business can expect to receive payments from customers or clients. In essence, they can play a key role in determining your company’s cash flow cycle by helping you project when funds will enter your account. You can then use these projections to make business growth plans and to help with tax planning. 

Payment terms are also helpful when you’re reviewing the age of invoices in your accounts receivable balances. Having defined payment terms can help prevent or resolve disputes by serving as a source of truth if disagreements arise, such as questions about charges or refund requests.

Payment terms can vary based on different factors—like the customer’s credit or industry standards—but here are some common terms you might see on an invoice:

• Payment in advance (PIA): The customer is required to make a payment before a product is delivered or a service is started. 

• Cash in advance (CIA): The payment must be made in full before an order is received. This is typically the least risky method for sellers.

• Cash on delivery (COD): The customer must make an immediate payment as soon as a product is delivered. 

• Cash next delivery (CND): To receive an order, the customer is required to pay for the previous delivery when receiving their next order.

• Cash before shipment (CBS): Payment must be made before items are shipped.

• Cash with order (CWO): When an order is placed, the payment must be included. 

• Net 30: The customer must make a payment to the seller within 30 days of the invoice date.

• 2/10 Net 30: The customer has the option to make an early payment and receive a 2% discount if the payment is made within 10 days of the invoice date. Otherwise, the customer should make the payment within 11 to 30 days of the invoice date.

• Net 60: The customer must make a payment to the seller within 60 days of the invoice date.

• Net 90: The customer must make a payment to the seller within 90 days of the invoice date. 

• End of month (EOM): The invoice must be paid by the end of the issued month with no discount offered.

• Month following invoice (MFI): The payment is due on a specific day of the month after the invoice is issued.

• Accumulation discounts: The seller provides a discount for large or cumulative orders.

• Partial payment discount: The seller provides a discount to encourage partial or early payment, often to improve cash flow. 

When negotiating payment terms, it’s important to recognize that some businesses have strict policies in place, while others may be open to negotiation when creating an agreement. Both sellers and buyers can work together to establish mutually beneficial payment terms. In general, shorter or more favorable payment terms improve cash flow for the seller, while vague payment terms can lead to unpredictability and gaps between anticipated and actual payment dates.

Before negotiations begin, you’ll want to assess your business’s risk level and working capital needs to determine how flexible your payment terms can be. From the customer’s side, you can review their credit history and reputation. For example, a customer with a stellar credit rating may expect more lenient payment terms because their track record demonstrates a higher level of creditworthiness.

It’s critical to ensure the legal framework surrounding your payment terms is compliant so you can help guarantee your company gets paid. Having provisions in place provides that protection if there’s a dispute, ensuring you’re covered if the customer doesn’t comply with the terms or seeks a refund.

When creating payment terms, clearly documented and legally compliant requirements can help align your business with its customers. Agreeing on payment terms ahead of time can prevent disputes and set a specific date for when you can expect money to be deposited into your account. As you determine payment terms, consider how they can help maximize your company’s cash flow to support projections and expand your company.

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