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Credit Terms: Definition, Factors, & Guidance

“Credit terms” refers to the length of time you give customers to pay for your goods or services. Once established, most businesses discover that it makes good business sense to extend flexible credit terms to their customers. Extending credit terms to new customers can attract fresh business. Allowing existing customers to pay on credit can build loyalty.

However, extending credit has an impact on your cash flow and can open you up to the risk of late or non-payment.

Creating an effective, well-monitored business credit policy covering your customer credit terms may seem daunting, but support is available.

Summary

Key takeaways

  • Credit terms set out length of time you give customers to pay for goods or services
  • A typical payment term of Net 30 means that payment is due 30 days from the invoice date
  • You may offer a discount for customers who settle their invoice before the due date
  • Penalties for late payment can help mitigate the risks associated with credit

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Understanding credit terms


Extending credit to your customers can be a way of attracting new business and building loyalty amongst existing customers. The terms under which you agree to extend this credit are set out in the invoice, including the date upon which payment is due. The invoice credit terms form the terms and conditions of the transaction.

Components of credit terms

Invoices set out the various components of the credit terms : 

Credit period

The credit period is the due date for payment.

The shortest credit period is “Net due upon receipt,” which means the invoice must be paid as soon as it has been received and checked. One of the most common credit periods for a small business is “Net 30”. This means that the invoice must be paid in full within the net period, 30 days from the date of the invoice. 

Discount terms

Extending credit terms involves the risk of customers paying late or not paying at all. Many businesses try to mitigate this risk by offering incentives, encouraging customers to settle their invoices promptly.

For example, you may decide to offer 1% off a customer’s invoice if they settle it within 10 days, rather than the 30 days indicated on the invoice. In this case, the discount would be presented as follows:

1/10
n/30

The “1” represents the percentage discount being offered, “10” represents the number of days the discount applies, “n” represents the word “net”, and “30”  represents the standard 30-day credit terms The customer is incentivized to settle their invoice early, which, even taking the discount into account, is usually beneficial for you.

Late payment penalties

Overdue payments can cause difficulties and are to be avoided. Establishing penalties for late payment is one way of limiting the credit risk, avoiding bad debts and the need to turn to a collection agency.

Your credit terms should set out any penalties in place for late payment. If the customer does not pay within the agreed deadline, they are in breach of the credit terms and interest might be payable. The amount of interest which can be charged on the credit is governed by what are known as “usury laws.” These laws are designed to protect consumers from excessively high interest rates by setting caps on the maximum amount that can be charged.

In Europe, for example, the interest rate applicable on late B2B payments is given in the European Commission’s Directive on Late Payments and currently stands at 12% per annum. This is based on the European Central Bank refinancing rate on the payment date, plus eight percentage points. 
In different parts of the world, different past due payment rates are set by local or regional regulations.

It is important to research and understand the relevant regulations which apply to your industry, depending on your geographic location.

Payment methods


The credit terms should also specify acceptable payment methods. This may include check, bank transfer, credit card and mobile payment options. Discounts for payment in cash can also be offered.  The key is to make payment easy for the customer while reducing the risk of non-payment.

Factors influencing credit terms


Several factors influence credit terms. These include industry norms, cash flow considerations, customer relationships and risk assessment.

Industry norms

Understanding your industry is essential to building a strong, successful business. It is important to understand the accepted payment terms in your industry. This allows you to align yourself with customer expectations, but also to potentially identify where your competitors may have left a gap in the market.

Cash flow considerations

Credit terms necessarily have an impact upon cash flow, as you will have to wait longer for the cash to flow into your business. If not managed carefully, this could result in cash flow shortages. Early payment discounts and overdue payment penalties can encourage prompt payment and reduce the impact on cash flow.

Customer relationships

Extending credit can attract new business. If all else is equal, but you offer flexible credit terms and your competitor does not, this might just tip the balance in your favor. 

Credit can also build loyalty among your existing customers. By extending credit to an existing customer, you show them they are valued and trusted. They may be inclined to make more or more regular purchases as a result.

Risk assessment

Before you extend credit terms to any customer, it is strongly advised that you check their creditworthiness. Allianz Trade helps businesses establish the creditworthiness of their customers, so that they can extend credit to them while mitigating the associated risks.

Determining credit terms


Once you have decided to extend credit, you need to establish the most appropriate credit terms, and this involves several steps :

Cash flow analysis


You need to analyze your cash flow situation to ensure you can afford to offer your customers credit. By offering credit, you are showing your customers that your business is stable and that you predict it will continue to be so in the future.

Discount structure

The aim of a credit policy is to ensure payment on time. You can take several measures to maximize your chances of being paid on time, including discounts for prompt payment and penalties for late payment. These discounts and penalties, set out in the credit terms, are designed to ensure your credit terms are respected.

Credit scoring


Ensuring your customers are creditworthy is the cornerstone of a solid credit policy. Checking your customer's credit reports, credit history and credit score can help you build up a picture of how likely they are to pay their invoices and set an appropriate credit limit.

Customizing credit terms


As a business owner, you know that there is no such thing as a one-size-fits-all approach. Every business should conduct an in-depth analysis of their industry, their own business, and their customers’ creditworthiness. Closely monitoring payment terms and due dates is essential to identifying any potential areas for concern and to ensure they can be resolved quickly and with flexibility.

Communication and transparency

Establishing clear and transparent credit terms and communicating them to customers is essential. Elements such as the due date, advance payment discounts and past due payment penalties should all be set out clearly on the invoice.

Conclusion

Extending credit to customers is a logical step once a business is up and running. Allowing customers to buy goods or services on credit can attract new customers and build loyalty among existing ones.

Managing credit terms is a cornerstone of any business credit policy. Gauging the creditworthiness of potential customers before extending credit can mitigate the associated risks.

Incentives to encourage early repayment and disincentives to penalize late payment should be built into the credit policy to ensure you do not encounter cash flow problems.

Allianz Trade helps business establish solid, reliable credit policies and to implement procedures to monitor them. 

Reduce Non-Payment Risk with Trade Credit Insurance

When you insure your accounts receivables with trade credit insurance from Allianz Trade, you can count on being paid, even if one of your accounts faces insolvency or is unable to pay. In addition, trade credit insurance from Allianz Trade comes with the added benefit of the support necessary to make data-informed decisions about extending credit to new clients or increasing credit to existing clients.

Our expertise and commitment

Allianz Trade is the global leader in trade credit insurance and credit management, offering tailored solutions to mitigate the risks associated with bad debt, thereby ensuring the financial stability of businesses. Our products and services help companies with risk management, cash flow management, accounts receivables protection, Surety bonds, and e-commerce credit insurance ensuring the financial resilience for our client’s businesses. Our expertise in risk mitigation and finance positions us as trusted advisors, enabling businesses aspiring for global success to expand into international markets with confidence.

Our business is built on supporting relationships between people and organizations, relationships that extend across frontiers of all kinds—geographical, financial, industrial, and more. We are constantly aware that our work has an impact on the communities we serve and that we have a duty to help and support others. At Allianz Trade, we are strongly committed to fairness for all without discrimination, among our own people and in our many relationships with those outside our business.