The Quick Guide to Net Terms for Sellers and Buyers (2024)

Flexibility is key to enabling business and building partnerships, and establishing payment terms is one of the greatest sources of flexibility for businesses. The option to schedule payments and manage cash flow directly impacts a company’s revenue creation and profitability. This is why many buyers seek flexible payment terms when selecting vendors.

In response to this buyer preference, many B2B and invoice-based businesses offer their customers flexibility through net terms. When sellers extend net terms to qualified clients, both parties benefit from a more consistent cash flow that enables growth.

Net terms are an extension to traditional pay-on-receipt invoicing. They allow customers more time to use their purchased supplies, generate revenue, and expand operations. They help smaller businesses pay invoices without running into cash flow problems or putting large amounts on a business credit card and accruing interest.

Today, we'll share an overview of net terms:

• What net terms are
• How a net terms arrangement works
• The benefits of net terms
• The disadvantages of offering net terms
• How net terms affect cash flow

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What are net terms?

Net terms — also referred to as trade credit — are the payment periods a supplier offers a customer to pay their invoice. They are typically expressed as a number of days after the invoice date, such as a “net 30 payment.” In the case of net 30, the customer must pay the full amount within 30 business days of receiving the invoice.

How do net terms work?

Net terms are an agreement between the buyer and supplier. The net terms agreement has several components.

Term: The term is the number of days before payment is due. Terms are determined by the vendor and accepted by the buyer.

Interest: With net terms, a set amount of interest accrues for payments made beyond the net payment date. This may be any rate set by the supplier up to the amount allowed by law. Usually, the average monthly finance charge on net terms is 1 to 2 percent.

Discount: Many vendors choose to incentivize payments by rewarding early repayment. A net discount is a percentage off an invoice total for payments made within the early payment window. For example, a vendor may offer a 3 percent discount on invoices paid in the first 15 days of a net 30 agreement. If you set net 60 terms, a 30-day early payment option may be appropriate.

What is the difference between net terms and a credit card purchase?

Net terms and credit card purchases extend credit and serve similar purposes: getting supplies into a buyer’s hands sooner. The primary difference lies in the specifics of repayment and the structure of incentives.

• Net terms are a form of trade credit extended by vendors to buyers, allowing them to pay for goods or services without an immediate financial exchange. This model often includes an interest charge on late payments or offers discounts for early payments, directly influencing cash flow management between businesses. The grace period in net terms might be similar to a 30-day grace on interest provided with a credit card.

• Credit card purchases involve borrowing from the card issuer up to a predetermined limit with an obligation to repay the borrowed amount plus any applicable interest or fees. Credit cards may offer rewards or cash back instead of discounts on early repayments.

While both methods provide delayed payment options, net terms are more directly negotiated between buyer and seller, whereas credit card agreements are standardized by issuing financial institutions. Net terms may provide more flexibility, as you can negotiate them past the typical 30-day window of credit card agreements.

Steps involved in the net terms process

Setting net terms for a repayment agreement is a straightforward process. Typically, you can expect the following:

1. Check history: For existing clients, consider their payment history before establishing net terms. For new clients, use a credit check (through Dun & Bradstreet, Moody’s, or a similar credit bureau) or check references to establish credit score and worthiness for the extension.
2. Set terms: At the commencement of services, enact an agreement outlining the early or on-time invoice amount, repayment terms, late fees, and any early payment discounts to apply.
3. Submit invoice: Send an invoice once the order is fulfilled. Sometimes, the repayment grace period begins as of the invoice issuance date. Other times, the clock starts on the postmarked date or date of invoice receipt.
4. Early payment: If the buyer pays the invoice within the allotted early repayment period, they pay an incentive amount that includes savings according to the contract terms.
5. On-time payment: For payments within the normal payment window, businesses pay the regular invoice total.
6. Late payment: If a client goes past the net terms payment window, they pay a finance charge on top of the invoice amount.

Types of net terms

Net terms are usually set at net 30 payment terms. Some suppliers have as narrow a window as net 15 payment terms, but this is less common. Other options include net 45, net 60, or net 90 days after the invoice, though sometimes businesses negotiate extended terms. Some industries have customary net terms expected by most suppliers and buyers.

Setting a net terms interval should balance supporting buyers with flexibility and meeting your internal business needs and goals. Setting net terms that are too long may provide an unnecessary amount of free financing to buyers and jeopardize your internal cash flow.

Invoice terms that are too short may make your company appear cash-poor or inflexible. Net 30 repayment terms are widely accepted and recognized. Follow your industry’s guidelines for extending terms on a 60- or 90-day basis.

Benefits of net terms

Vendors extend trade credit to their customers to add flexibility to the transaction while maintaining stability in internal finances. Most companies recognize the value of net credit terms arrangements and their specific benefits, which include:

• Improved cash flow for customers since buyers do not have to pay immediately
• Higher customer satisfaction due to more convenient payment terms
• More customer loyalty from customers who benefit from the extension
• Increased sales revenue by attracting new customers who need flexibility
• Improved relationships with buyers who benefit from a supportive supply partnership
• Enhanced ability to offer discounts or incentives for early payments

The risks of offering net terms

Extending net terms to customers requires suppliers to assume a certain amount of risk. Non-payment, administrative burdens, cash flow issues, and other challenges can make it hard to offer extended terms safely.

Collection challenges: Pursuing overdue accounts requires a delicate balance between maintaining customer relationships and ensuring payment. The need to use aggressive collection tactics can damage long-term business relations.

Administrative overhead: Managing net terms requires significant administrative effort to track invoices, monitor due dates, and chase late payments. This can strain resources and detract from other business operations.

Credit limit determination: Deciding on credit limits for each customer involves assessing their creditworthiness, which adds complexity, requiring additional time and possibly external resources.

Cash flow disruptions: Relying on future payments with net terms can disrupt cash flow, especially if a significant portion of your revenue is tied up in outstanding invoices. This might necessitate external financing to cover short-term needs, adding additional costs.

Impact on pricing strategy: The need to offset the risks associated with offering net terms might lead to higher pricing for all customers, potentially making your products or services less competitive.

Types of businesses that offer net terms

While some consumer-focused companies like Affirm and Klarna offer longer payment terms through “buy now, pay later” platforms, most companies that offer trade credit work with other businesses.

Three of the most common places you’ll see net terms include:

B2B companies: Companies that primarily offer services and products to other businesses often agree to net terms. This strategy helps them secure more customers who may not have the funds to pay upfront, allowing them more flexibility.

Invoice-based services: Companies that invoice for goods rather than charge with point-of-sale or pay-on-receipt billing often extend flexible net terms to customers. While some companies need payment on receipt or at the end of the month (EOM), customers may expect the flexibility of extended terms for larger invoice balances.

Product and parts sellers: Retailers that sell finished products or components (for example, parts for automobile repair) often extend terms to their customers. This allows the buyers to get parts in stock, generate revenue from sales or repair services, and use the proceeds to pay off the invoice on time.

The type of extended terms and discounts you’ll find depends on the business, region, and industry.

How net terms affect your cash flow

Healthy businesses are all about cash flow — and if done properly, net terms boost your business’s access to cash. Net terms affect businesses on both sides of the table.

Buyers: Net terms attract buyers looking to maximize their working capital. They allow the buyer to get supplies in the door without tying up cash. With materials in hand, they can produce and sell their product or service, bring in cash, and pay their bills on time. Net terms are especially important for startups and small business owners relying on credit to get supplies and drive revenue.

Sellers: Vendors that offer net terms gain access to a wider range of customers. Instead of relying only on cash-rich clients with more established businesses, they expand their services to young, innovative companies that need services and tools to scale. Provided this diverse client base pays in a timely manner, this increases cash flow.

Offering early payment discounts benefits both parties. Buyers can be more cost-competitive and retain working capital, while sellers get revenue in-house faster.

Use Order.co to enhance the benefits of net terms

A procurement management platform with flexible payment options helps buyers and sellers maximize their working capital. It facilitates access to a network of high-quality products and vendors, with terms that make it easier for businesses of any size to streamline their procurement and accounting processes.

Order.co provides features that make life easier for buyers and sellers by offering:

• Access to both standard and extended net terms and cash advance options for flexible buying through the Order.co Financial Offerings
• Universal net terms so customers can always expect 30 days to pay with no fees, plus extended terms options for businesses of any size
• Fast credit approval with decisions rendered in 2 to 3 business days and no paperwork
• Revenue-friendly terms that allow growing businesses to scale first, pay later

To see Order.co in action and improve cash optimization and accounting for your business, schedule a demo.