Accounts Payable 101: What payment terms are best for my business

Payment terms detail how and when you must pay your vendors for the goods and services they provide your company. Typically, the terms will outline when payment is expected, the penalties or ramifications of late payment, and whether there are any incentives for early payment.

What types of payment terms are there?

There are several payment terms that companies may offer. Let's take a closer look at what each means.

• Prepayment - Under these terms, full payment must be received before the goods or services are delivered.
• Immediate payment - Payment in full is expected upon receipt of the goods or services purchased.
• Partial payment - Vendors may ask for partial payment upfront, allowing you to pay in smaller chunks.
• Installment - Similar to partial payment, installments are small payments set up over a period of time, such as every three months. However, installment payments may not require payment upfront as a partial payment term does.
• Line of credit - offers buyers financing toward products and services; customers repay the balance on the agreed payment schedule.
• Net payment terms - the agreed-upon period in which a buyer must pay an invoice to a seller for goods or services they have provided.

It's this final example that most accounts payable teams will deal with. Net payment terms also typically come with an attached number, representing the number of days within which they must pay the invoice. For example:

• Net 15 - The customer has 15 daysto pay the invoice.
• Net 30 - The customer has 30 daysto pay the invoice.
• Net 60 - The customer has 60 daysto pay the invoice.
• Net 90 - The customer has 90 daysto pay the invoice.

What are the pros and cons of each term as a seller and a buyer?

As a seller, you want to receive payment as soon as possible, while a buyer will want to delay making payment for as long as possible. With that in mind, let's look at some of the advantages and disadvantages of each term described above.

• Prepayment - This benefits a seller greatly, as they receive their money upfront. It's such an advantage that sometimes sellers will provide a discounted percentage for organizations that make payments upfront.
• Immediate payment - The benefit here is similar toprepayment, as it will aid sellers that prioritize quick cash inflow. That said, it may not be a feasible option for many buyers.
• Partial payment - This option allows a seller to get quick access to working capital that may help finance the goods and services requested by the customer. From a buyer's perspective, this can break payment up into more manageable segments.

• Installment - As with partial payment, this option makes payments more manageable for the buyer.
• Line of credit - A line of credit greatly benefits the buyer, as it allows them to purchase with no upfront payment or collateral required. The risk comes from the seller's side, given that customers may pay late or default on a debt completely.
• Net payment terms - Choosing this option may inconvenience you as a seller because you'll have finished the project or delivered the product without receiving income. However, buyers will likely prefer these terms.

What are early payment discounts?

As the name implies, early payment discounts are discounts provided to customers who pay their invoices before the agreed-upon due date. As an example, a company may offer Net 30 terms, meaning that an invoice must be paid 30 daysafter receipt. As part of this deal, they may offer a 2% discount on the invoice total if it is paid within the first 15 days.

For a seller, offering this discount provides the benefit of getting cash into the business faster. However, there can be several drawbacks. If margins are tight, offering a discount can potentially eliminate any profit. In addition, some customers may already pay early without an incentive. In that case, there is no tangible benefit to offering them an incentive for something they already do.

On the buyer's side, you may want to take the discount if it is financially beneficial for you based on the reduced expense and your financing costs. For example, if you have plenty of cash and do not have it earmarked for other activities then you will likely want to take the discount to reduce your expenses.

How do I renegotiate my payment terms?

When it comes to seeking better terms from a seller, there are several key things to remember that will help you succeed.

• Prioritize who you negotiate with - Don't try to renegotiate terms with all your vendors simultaneously. Instead, focus on those that represent the largest portion of your expenses. Companies that you spend a significant amount of money with are those most likely to be open to amending your payment schedule.
• Make sure you're speaking to the correct person - Check your initial contact to see whose name is on it. They will likely be a good first contact to begin renegotiations. Another potential candidate is your account manager or representative with the company.
• Know your current terms - It sounds basic, but you can't negotiate better terms if you aren't aware of your current terms. Make sure you have a comfortable knowledge of your existing contract before beginning negotiations.
• Aim for mutual benefit - A supplier is more likely to agree to your requests if they feel there is something in the deal that will benefit them as well. For instance, you may suggest that more generous payment terms would allow you to increase the amount of business you provide them.
• Schedule a formal meeting - You'll want to conduct negotiations when all parties involved can fully commit to the conversation, and this can only happen during a formal meeting. As part of the meeting, it is helpful to create a document outlining your current terms and exactly what you are seeking to change.
• Aim High - While you want to be reasonable in your request, it's a smart strategy to aim high and start negotiations at the higher end of your ask, that way when you compromise you can settle into a final amount that is still acceptable and beneficial to you.
• Get it in writing - Once a new agreement is reached, you'll want to make it official as soon as possible. Send written follow-up, recapping the relevant details from your conversation and outlining the new terms agreed upon. It will help to have your business attorney involved in this portion of the process.

Take accounts payable to the next level

Getting the terms that are optimal for your organization is the first step in elevating your company's finances. You can take this even further by streamlining your accounts payable process through AP automation.

To discover how AP automation lowers costs, increases efficiency, and improves cash flow, schedule a demo today.