Net 30 Credit Terms

See Also:
How Important is Personal Credit in Negotiating a Commercial Loan
How to Improve Your Credit Score
Letter of Credit
Line of Credit (Bank Line)
How to collect accounts receivable

Net 30 Definition

What is 2% 10 net 30? Or 1% 10 net 30? The credit terms 2% 10 net 30 means the customer gets a 2% discount if the bill is paid within 10 days. Otherwise, the full amount of the bill is due in 30 days. Net 30 credit terms represent incentive discounts that suppliers offer to encourage buyers to pay promptly. When a product is sold on credit, the supplier delivers the product to the buyer and the buyer agrees to pay for it later. Additionally, net 30 credit terms means 30 days before a penalty for late payment is accrued. It is a mainstay in business to business sales.

Net 30 Credit Terms Explanation

For those who have just heard about net 30, explanations are needed to understand why it is so commonly used. Net 30 payment terms, with a discount for early payment, induce the buyer to pay earlier. According to the net 30 definition, the total amount of the bill is due in thirty days, but if the buyer pays earlier, the buyer will get a discount of 1% or 2% of the bill, depending on the net 30 payment terms.

Credit Sales

To understand 2 percent 10 net 30 payment terms requires an initial understanding of credit sales. Sales made on credit are essentially like offering an interest-free loan to the customer. In this sense, it represents a cost to the seller and motivates the seller to try to collect receivables as soon as possible. It also represents a benefit to the customer, who is motivated to postpone payment as long as possible. When a customer can hold onto cash it owes to a supplier, the customer is benefiting from an interest-free loan from the supplier via the credit sale. Net 30 vendors bridge the gap between the benefits of trade credit and the disadvantages of slow AR turnover.

Average Collection Period

The average length of time it takes a company to collect payment for credit sales from customers is called the average collection period. A shorter collection period shows a company that is able to collect its receivables quicker and thereby reduce the implied cost or opportunity cost of the interest-free loan to the customer. On the other hand, a company that has a comparatively long average collection period is clearly having trouble collecting payments from customers and this could be a sign of inefficient operations. 2% 10 net 30 days can be one of the many solutions to alleviate this problem.

Net 30 Credit Terms Calculation

For net 30, calculators are not necessary when you understand how the system works. If the buyer decides not to take advantage of the 2% discount by paying within ten days, the buyer is essentially paying 2% interest for the benefit of holding onto the cash for 20 more days. When considered in this way, the buyer’s cost of foregoing the discount amounts to about 36.5% per year. This is because the buyer is essentially paying 2% interest on a 20 day loan; there are 18.25 twenty-day periods in a year; so 18.25 multiplied by 2% equals 36.5% per year (36.5% = 2% x (365/20) . Likewise, by foregoing the 1% discount offered for payment within 10 days is costing the buyer 18.25% per year.
36.5% = 2% x (365/20)
18.25% =1% x (365/20)
So, even if the customer doesn’t have the cash on hand to pay the bill within the 10 day window, as long as the customer can obtain cash for a borrowing cost less than 36.5% (for a 2% discount) or 18.25% (for a 1% discount), that customer would be better off borrowing the money to pay the bill early so as to benefit from the discount offered by the credit terms.

Net 30 Credit Terms: Example

When thinking about the 2% 10 net 30 meaning, an example provides perspective into the idea. Let’s say a manufacturer sells widgets to a retailer for $1,000 and the manufacturer offers the retailer credit terms 2% 10 net 30. The retailer can get a 2% discount on the total bill if it is paid within ten days. In this case, the total net 30 invoice, after the discount, would be $980 and the retailer would save $20.
$980 = $1,000 – (2% x $1,000)
If the retailer foregoes the discount, the full amount of $1,000 will be due at the end of the thirty day period. In this case, the retailer essentially paid (or gave up) $20 in order to postpone payment for 20 days. Hypothetically speaking, if the retailer were to pay $20 dollars in order to postpone payment for every 20 day period in a year, then that would amount to a total yearly cost of $365 ($365 = $20 x (365/20)). Under most circumstances, when offered credit terms 2% 10 net 30, it is in the customer’s best interest to take advantage of the discount and to pay early. Net 30 accounts provide benefit to both the vendor and client.
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