What are Net 30 Payment Terms?
As a wholesaler and distributor, you’ll commonly use and come across Net 30 payment terms. Despite the technological sound of it, this merely states a form of trade credit. Net 30 means that the total amount outstanding on the invoice is expected to be paid in full by the buyer within 30 days of shipping out the goods or completing the job.
So, in reality, this is a form of short-term financing. It allows the buyer to purchase goods or services without immediate payment to the seller. In fact, trade credit is the largest use of capital for most B2B sellers in the United States. And it’s a critical source of capital for most businesses.
Here, we’ll cover more common payment terms along with examples. Then we’ll explore incentives to encourage early payment of invoices. Moving on, we’ll see how they’re used around the world in different countries. Finally, we’ll also consider alternatives to net payment terms and how they work.
History of Net Payment Terms
Net here doesn’t refer to the Internet. It means the total after all discounts. The origins can be found in ancient Latin: nitere (to shine) and nitidus (elegant, trim). In French, net also means sharp, neat, clean. The habit has stuck since ancient times and net or nett is commonly used around the world. Both words mean the same thing.
Other net payment terms in the normal course of business include Net 10, Net 15, and Net 60. These mean payment is due in 10, 15 or 60 days. They can sometimes be written as Net-30 or Net 30 days. So Net 30 means that the buyer will pay the seller in full on or before the 30th calendar day, including weekends and public holidays.
For example, an invoice for $1399.00 has the terms “Net 30”. This means that full payment is expected within 30 days. The countdown starts from the time the goods were dispatched or services provided in full. It does not necessarily follow the calendar month. But we shall see that this practice is sometimes followed in other countries.
Sometimes payment terms can be written in plain English. For example, “due in 30 days”. This might be better for consumers who might not understand the net terms lingo that is commonly used between businesses. This is essentially the same as net 30, except now it is made clear that full payment is required in 30 days from the date of the invoice.
You may also encounter something like “2% 10, net 30”. This means that a 2% discount on the invoice applies if payment is made in full within 10 days of the invoice date. Otherwise, full payment is expected within 30 days. The discounts can also be written as “2/10, net 30”. This means the same thing as the earlier example.
In accounting, they are known as discount terms. They are written in two parts. The first part is the percentage discount. The second part is the number of days that you need to make payment in order to enjoy the discount. This gives buyers an incentive to pay up earlier. And it gives the seller a boost to their cash flow if the discount is taken up.
You need not immediately offer discounts upfront to your customers. You are in control of your payment terms after all. What you should do is be selective about who you are extending trade credit to in the first place. New customers should not enjoy discount terms. Instead, you could specify Net 21, Net 15 or even Net 10 to gauge their promptness first.
If there’s an incentive to pay up early, how about penalties for paying late? This is where penalty interest is applied. The interest differs by country but it should be a high enough interest to incentivize customers to pay up in full, on time. You should be levying an effective interest that is similar to that charge for business credit by the banks.
As expected, there are typically penalty interest terms that vary according to the purchase agreement. For net 30, penalty interest starts to accrue from the 31st day until full payment is made. This is a message from the seller that this avenue of credit is used up and it’s time to make payment. It also allows the seller to use capital elsewhere that may otherwise be tied up in outstanding invoices.
It’s worth noting that transit time is included in counting the number of days. So a shipment that takes 9 days will have 21 days left to make the full payment. Buyers, in this case, prefer to unload and inspect the goods for damage before making payment. Other buyers may prefer to see if the services rendered were done according to their requirements and satisfaction.
Why Net Payment Terms?
Why do net payment terms exist at all? Surely we can simply insist on full payment of the invoice upon delivery of the goods or completion of the job? Well, for most businesses there may be a lengthy invoice approval process. Some larger organizations may be saddled with bureaucracy. So, verification and cross-checking of PO numbers may take 3-5 working days itself.
Another reason is that businesses need time to review the invoices raised. This is to prevent fraud by employees. Others may need time to arrange payment for invoices. Some businesses collect invoices in a batch. Then present them for approval in a batch. Finally, check writing and signing is arranged in a batch. Only then can payments be mailed out.
But most importantly, net payment terms is an extension of credit from you to your best customers. Regular customers will appreciate standard net 30 or generous payment terms. This allows them time to get their affairs in order and arrange payment. It’s also a signal of confidence from you that your customers can make final payments on time.
By offering Net 30, you’re giving your customers a greater incentive to purchase from you. Buyers know that they will enjoy 30 days of interest-free credit with you before the full amount is due. For some, they may enjoy discount terms if they pay earlier. It’s almost a given around the world that businesses expect that they have 30 days to make payment.
Where Net Payments Don’t Work
As you can guess, net payment terms are not suitable for all businesses. Service providers, such as tradespeople, prefer payment in full upon completion of the job. And they’ll make this clear when they are booked for the service. With their high volume of typically one-off jobs, they would prefer to collect payment upon completion of the job.
Similarly, wholesalers with small invoices prefer payment before goods are shipped out. Purchases are typically one-off and their margins are slim. They prefer to be paid for their goods upfront before they are delivered to the buyer. Collection of many small outstanding invoices will only add to their staff costs, time and effort.
On the other hand, wholesalers that deal in big-ticket items such as industrial machinery will inevitably extend net payment terms. Their invoiced quantums are large and they will no doubt go through a payment approval process at the buyer’s company. Extending trade credit here is a firm signal that they appreciate the buyer as a regular customer.
Net Payment Terms Around the World
For the United States, businesses and most government agencies use net 30 terms. For contractors and those providing services, Net 10 and Net 15 are popular for the quicker collection of payment for services provided. Net 60, however, is not widely used because of its long, two-month payment period.
In the United Kingdom, a statement such as “net 30, end of the month” or “Net Monthly Account” means that payment in full is expected by the end of the month following the month of the invoice. This gives the purchaser additional days of credit depending on when the purchase was made. Savvy buyers will tend to make purchases in the first week of the month to take advantage of these British terms.
Why Net 30 May Be Bad For Your Business
After covering all the benefits of Net 30, it may surprise you that it could be bad for your business. But how? Net payment terms have different effects on your business depending on your size and financial strength. Generally, larger businesses thrive with Net 30 while smaller businesses and freelancers suffer with Net 30.
Generally, big businesses have stable and perhaps multiple streams of revenue. They also typically have many customers. All these work to ensure that they enjoy the benefits of Net 30. Their customers may pay on a rotating basis so any delay by one is offset by another. So large businesses are buffered from any drawbacks of Net 30.
Also, net payment terms may be stretched by large customers. If you’re a small wholesaler, you’re effectively held hostage by the favorable buying terms of large customers. You wouldn’t want to pass a large order, but you don’t necessarily want to extend far too generous credit if possible. Big customers may demand net 30 or longer payment terms.
Finally, some customers may take advantage of vague payment terms. “Due upon receipt,” is one that we’ve seen on some invoices. This is not good for business because number one, it can be interpreted as “not urgent” because no due date is set. Also, buyers may apply whatever payment terms they see fit to make sure payment is made upon receipt. This may be 7 days, 14 days or 28 days.
Alternatives to Net Payment Terms
A common alternative to net payment terms is consignment sales. In this case, the buyer takes possession of goods from the seller. But the buyer doesn’t actually purchase them until they are sold. Ownership of the goods passes to the buyer then. Unsold goods can be returned to the seller according to the terms of the consignment agreement.
So, the buyer enjoys a form of trade credit as payment is not made to the seller until the goods are sold. It is also an example of risk shifting. The buyer takes little or no risk by stocking up on the seller’s goods. The seller bears most of the risk by extending a payment-free purchase period but the goods may be made obsolete, damaged or stolen during this time.
Another alternative, particularly for freelancers and the self-employed, is milestone payments. These are effectively installments spread over the timeline of a project. You would have agreed beforehand to the project amount and the dates that you should be paid when certain jobs are completed and delivered. These payments are best suited for project-type work.
Get A Grip on Your Invoices
Since Net 30 payment terms are here to stay, the next best thing is to use inventory management software or accounting software to manage your customer (and supplier) invoices. Get a handle on them by using cloud-based software so that your invoices are digitalized and not lost in a pile of paper. Does this scenario sound familiar?
EMERGE App, for example, includes fields for the invoice date, due date, and any credit terms that the customer may enjoy. It also show a handy summary of any amounts outstanding for the invoice along with the number of days overdue.
Net payment terms make the business-to-business world go around. Without it, it would be very difficult for businesses to transact with each other. Net D payment terms are extended to buyers because the seller trusts that the buyer can pay the full invoice on time. It also gives the buyer time to receive the goods, inspect them, arrange for payment approval, and then send the payment to the seller. Use them if you wish and match them to your specific business.