Money Matters

How to establish payment terms

If you’re wondering how to establish payment terms with a customer, there are a few key things to think about.

People always focus on the price, yet can get fazed when they are asked, so what are your payment terms? And when you get asked that question, you need some answers ready.

Payment terms are in effect all about offering someone credit. And that means, are they good for it?

Because once you issue an invoice, and don’t take cash for your goods and services at the point of sale, you are offering your customer a line of credit. And that means you take on the risk of them paying late, or worse, not at all.

Now, let’s make one thing clear, the best outcome is to get paid immediately. The best invoice you can issue is one which acts as a receipt.

Let’s hear what Stefan Fritz, Managing Director of the Lady of Avenel boat business, has got to say about how to establish payment terms. He’s skipper of the Lady of Avenel boat, a traditional sailing boat based in northern Scotland.

It’s a lifestyle business, something which Stefan and his team love doing. He is quite firm about terms: “We take a deposit before we do anything, if there is no deposit, we won’t do anything. And generally, we get paid for the trip immediately…we don’t have problem chasing money too much.”

Great advice for anyone in business, but of course it all depends on what business you are operating. For many businesses, especially in the B2B world, payment terms must be negotiated, alongside the price. With B2C businesses, there often is more of an opportunity to dictate good terms, for you the business owner, right from the kick-off.

Examine your cash flow

We asked expert Nicky Larkin for her opinion on how to establish payment terms. The Managing Director and founder of Goringe Accountants, Nicky was a finalist of the British Accountancy Awards 2012. She is also Chair of the FSB Reading & West Berkshire branch. Goringe, based in Reading, has around 700 clients.

She has wide experience in setting up finance teams and systems, managing all aspects of financial and management accountancy, installing best financial practice and gaining company financing.

Nicky told us: “To establish payment terms, its key to look at your cash flow, because it’s really important to ensure that you have sustainable cash to grow your business, it’s very easy to have a profitable business, but actually you could be over trading and your growth could be stunted because you have a lack of cash.”

And, it’s fair to say, that most of your customers will be looking for good terms and those terms could make the difference between winning a deal, or not. So, you have to box cleverly.

First, there’s that question, are they good for it? You should always check companies and individuals out, especially if you are offering a lot of credit. There are services available which can give you a good steer on a customer’s financial standing and likelihood to pay.

But don’t forget, that no matter how many stars and ticks you get about a company, on the day it comes down to whether they can pay on the agreed date. So, as well as any checks you might get to help you, use your gut instinct.

Ask yourself how well do you know a company, or the individual buyer? What are people saying about the company online, or better still, are you able to speak to any suppliers who already deal with the company? What do they say about them?

How long can you wait?

So, next question is how much credit do you want to give them and for how long? It’s a good discipline for every company to adopt with a new customer, no matter how big the order, or attractive the margin. Be wary of companies that will use you to bankroll their business – selling your goods, taking the money and then delaying payment to you.

Let’s hear from Nicky again: “Obviously in each sector there are often traditions of payment terms, so you might only have a certain amount of flexibility for your payment plans, but whatever you can, try and shorten your payment terms to your customers as much as possible, so whether you can look at up-front payments, whether it’s deposits, or payments that are made early, or in advance, perhaps you might offer special little discounts by having your payments made in advance to give your clients some encouragement.

“After all, if your clients have lots of cash in the bank and they won’t be earning a lot of interest in there, so they might appreciate a couple of percentage points off your price if they pay up in advance.”

The most common terms offered to companies is 30 days, which is a fair amount of time that suits both parties. Which might be an odd thing to say, from the seller’s point of view, but don’t forget that those 30 days can be as important to you, as the buyer, as it’s time for you ensure that your products are delivered on time, are up to the job and perform as expected. Likewise with services, have you offered what you promised and what was expected? It’s a fair breathing space for both parties.

Some companies require you to give them 60 days, or even 90 days (which are not uncommon requests, especially in certain sectors), but if asked for this, you have to ensure you have the cash flow to stand it (back to Nicky’s earlier point).

You have to ask yourself the very honest question, can I afford not be paid for 60, or 90 days, effectively two to three months, for these goods, or services. And that’s not the only question. You have to say to yourself, two to three months is a long time in business, so your risk of not being paid has increased.

But, payment terms are part of the negotiating process, so remember what Nicky tells us about getting to as few days as possible. Less than 30 is great and anything over 30 requires you to make sure you can afford it.

And don’t forget that these terms must be on your invoice. They must be clear to your customer and confirmed in contracts, letters, or emails. They must not become an issue between the negotiating parties.

Last word of great advice goes to Nicky: “What’s also really good is if you try to be really strict with your payment terms. If you ask for money in advance, make sure you follow up on that. If your payment terms are 30 days make sure you are chasing up in advance of those 30 days and asking clients if they have their invoice and are set up to pay on 30 days. Make sure that you are really clear and your clients are prepared to pay within this terms.”