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Define Payment Terms

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Terms of Sale
Net 30 Credit Terms
Cost Recovery
2/10 net 30
Down Payment

Define Payment Terms

Define payment terms as the terms required for payment on a product, are a function of the service offering of a vendor. These terms are an extension of how a vendor wants to treat a customer. Common policies are 2/10 net 30, pay in 30 days, payment terms l c (line of credit), cash on delivery, telegraphic transfer, and more. A payment terms discount may even be offered by vendors as a benefit of a purchase.


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Payment Terms Explanation

Payment terms, explained as the terms which dictate when a vendor must be paid, vary in policy. Some businesses accept no payment terms: they receive cash on delivery (cod) or even before the product is given to the customer. Other businesses offer payment terms as a perk of becoming a client. These terms may be pay in 30 days, a 2% discount for paying within 10 days (2/1 net 30), and other terms which allow the customer to pay later.

Furthermore, vendor financing is another payment term. The occurs when the customer pays interest but is allowed to repay the cost of the product they have received as they see fit. A line of credit is a form of vendor financing when it is received from the provider of goods. Payment terms are often negotiable, so some businesses may have the policy of payment terms dnd. Dnd, here, means do not disclose. This generally means that the vendor will want to talk with the client to allow for assessment and negotiation of individual situations.

Additionally, payment terms and conditions exist. Conditions on payment may be as briefly listed above; cash on delivery (cod), payment is to be received in a foreign currency, and more. In this situation it is up to the vendor to decide the payment terms and conditions which should be offered to the client.

Additionally, certain payment methods may be required. Payment terms t t indicate that telegraphic transfer is required. Other methods differ greatly depending on the situations of both parties.

Payment Terms Example

For example, Joel has a company which provides cleaning of outdoor areas. Their business has many specialties that include pressure washing, chemical cleaning, and even cleaning residential back yards with dogs and other pets. This industry also requires many products and tools for operations.

Joel needs a new pressure washer. To get this item, he will purchase it from one of his favorite vendors. Fortunately, they provide payment terms which Joel appreciates.

This company offers 2/10 net 30 terms. This means that Joel can pay within 30 days of receive a 2% discount by paying in 10 days. Joel likes this because it will allow him flexibility in his decision making.

With these terms Joel decided to pay in 10 days. By receiving the discount, he has more cash to use on his business. With payment terms like this, he will stay with this vendor for a long time. For more ways to add value to your company, download your free A/R Checklist to see how simple changes in your A/R process can free up a significant amount of cash.

Define Payment Terms

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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.

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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.

For more ways to add value to your company, download your free A/R Checklist to see how simple changes in your A/R process can free up a significant amount of cash.

Net 30 Credit Terms

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Net 30 Credit Terms

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Net Sales

Net Sales Defined

What is net sales revenue? Net sales revenue refers to a company’s total sales revenue in a given fiscal period after subtracting certain items. These items include returns, allowances, and discounts. Net sales revenue is in contrast to gross sales revenue. Gross sales revenue is not adjusted for returns, allowances, and discounts. The revenue shown in the top line of a company’s income statement is net sales revenue. Net sales revenue is also called net revenue, net sales, or the top line.

Net Sales, Gross Sales

Companies earn revenues by delivering goods and rendering services to customers. Call the total amount of all revenues generated by a company in a given fiscal period the gross sales revenue. Gross revenue, however, is not always the most accurate representation of a company’s sales. Oftentimes customers will return damaged goods, receive a discount from the typical selling price, or demand a refund for some other reason. The revenues depicted on a company’s income statement would be more accurate if it took these items into consideration. And in fact, that is how we get to net sales revenue.

Contra-Revenue Accounts

Net sales revenue is simply gross sales revenue less returns, allowances, and discounts. These deductions from gross sales revenue are called contra-revenue accounts, because they are subtracted from the sales figure. While sales and revenue accounts are increased by credits and decreased by debits, contra-revenue accounts are increased by debits and decreased by credits. Also, refer to contra-revenue accounts as contra sales accounts.

Sales Returns

Sales returns refer to products that were sold and delivered to customers and then subsequently returned by the customer because of a lack of satisfaction with the product for one reason or another. When an unsatisfied customer returns a product, the company must give the customer his or her money back. Account for this refund in the company’s revenues; include the sum of all actual or anticipated refunds in the net sales revenue figure.

Sales Allowances

Sales allowances refer to refunds provided after-sale to customers because of damage to the products, missing products, or minor defects in the products. These issues cause the customer to be dissatisfied with the product. Because of these inadvertent flaws in the product and in order to retain the customer’s business, the company may provide refunds for sales allowances. You must then subtract the amount of the sales allowances from gross sales revenue to yield net sales revenue.

Sales Discounts

Sales discounts refer to reductions in sales prices to customers based on discounts, such as 2/10 net 30 credit terms. Such terms are designed to motivate customers to pay invoices sooner rather than later. Selling companies then offer discounts to customers who are willing to make early payments. Then subtract these discounts from gross sales revenue to yield the net sales revenue figure.

If you want to find out more about how you could utilize your unit economics to add more value to your organization, then click here to download the Know Your Economics Worksheet.

Net Sales

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Net Sales

See Also:

Net Income
Net Operating Loss Carryback and Carryforward
Allowance for Uncollectible Accounts
Business Intelligence and Finance
Are You Collecting the Data You Need to Run Your Business?

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How Factoring Can Make or Save Money

See Also:
What is Factoring Receivables
Accounting for Factored Receivables
Journal Entries for Factored Receivables
Can Factoring Be Better Than a Bank Loan?
History of Factoring
Factoring is Not for My Company
The What, When, and Where About Factoring
Nest Egg

How Factoring Can Make or Save Money

Opportunity for Discounts:

Lack of cash flow frequently causes a business to miss out on discounts offered by suppliers. Not taking advantage of these discount opportunities results in paying a higher cost of goods. Plus, many suppliers will negotiate even higher discounts for a customer who demonstrates the ability to consistently pay in cash within the discount period. Generally the best price is not the published price or terms. Rather, the best price is the negotiated price. This price is based on increased volume and negotiated terms backed by cash or quick pay. So, taking advantage of discounts gives a business the ability to add as much as 2 to 5 percent to its gross profit margin.

Administrative and Clerical Costs:

The clerical and data entry costs used in the physical processing of accounts are additional cost factors. Examples of physical processing include generating and stuffing statements. Depending on the size of the company and relative size of the accounts receivable, this may involve a full time employee, a larger accounting staff, or a current employee handling this responsibility as part of a diverse job description. The labor costs involved come into play on both ends. It includes:

  • The labor involved in generating and sending the statements
  • The administrative duties of receiving and posting account payments

Postage and printing costs add up when companies produce and mail large numbers of multi-colored statements on a regular basis. You must also consider these costs.

Management Resources:

Many overlook management’s time. In addition, many often overlook the missed opportunity of time spent doing something more productive. Reviewing accounts, placing calls to late-paying customers, and generating reports for analysis are all time consuming tasks involved in managing receivables and controlling cash flow.

Missed Opportunity:

Possible growth opportunities missed due to a lack of cash flow should also be taken into account when analyzing receivables management. Adequate cash flow is the single most important factor in achieving and sustaining business growth aside from market opportunity. Most businesses would have an extensive list of opportunities for growth and expansion to pursue if all receivables on the books were paid in cash today. Some examples of what could be accomplished if a company had access to cash instead of carrying customer debt include the following:

  • Bidding on new jobs
  • Investing in new equipment
  • Expanding the sales force

Furthermore, inadequate cash flow is like wearing handcuffs when it comes to growing a business. Improved receivables management, resulting in money in the bank and less or no debt, creates the environment and the attitude to set a goal and achieve the next level of growth and success.

Contributing Cost Factors

Once all contributing cost factors are estimated and totaled on an annualized basis, divide this number by total annual sales to determine a quantifiable cost for managing accounts receivable as a percentage of sales.

Payment Terms

Providing commercial customers with payment terms is a necessary part of doing business and an essential component of building good customer relationships. Performing this type of analysis on a regular basis highlights areas for additional savings and increases efficiency. In addition, knowing the actual cost of managing receivables and controlling cash flow allows for the implementation of more effective management strategies for the business as a whole. There are options available in the marketplace to help improve cash flow and receivables management, such as accounting consultant services, cash flow management systems, and factoring programs. Analyzing the true cost of receivables management is the first step in determining if these options make sense for a business by ultimately improving its bottom line.

If you want more tips on how to improve cash flow, then click here to access our 25 Ways to Improve Cash Flow whitepaper.

how factoring can make or save money
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Discount Payback Period (DPP)

See Also:
Discount Rate
Discounted Cash Flow Analysis
Discounted Cash Flow vs IRR

Discount Payment Period (DPP) Definition

The Discount Payment Period (DPP) refers to the period of time in which a payment on a purchase can be made for a discount incentive. A DDP can lead to advantages for both sides of the transaction. On one side, if the buyer makes the payment during the DDP, the buyer saves money and drives down costs. On the other side of the coin, by giving a discount based on an incentive to complete transactions earlier, the seller turns over the business cycle by receiving cash for the accounts receivable earlier than normal. As one can see, both parties benefit from utilization of the Discount Payback Period.

Discounted Payback Period Example

For example, Raincorp., housed in San Francisco, makes a purchase of merchandise from a different company, Dynamerch. The payment of the sale is due in 30 days with interest incurred afterward. During this sale, Dynamerch informs Raincorp that they will implement a Discount Payback Period. If Raincorp makes the payment in under 10 days, then a 2% discount will be deducted from the actual payment amount. If the payment is made in less than 5 days, then 6% will be deducted from the actual payment amount.

Raincorp makes the payment to Dynamerch in 4 days; therefore, Raincorp will receive a 6% discount on the merchandise payments they owe to Dynamerch.

Discounted Payback Period Explanation

The way in which the Discount Payment Period (DPP) is organized is very simple. The invoice that is given to the buyers is in a specific notation. This notation is interpreted in two very simple ways. In the example above, the notation for the discount would look like this: 2/10, 6/5, n/30. As said before, it is not very difficult to interpret these invoice short-hands.

For the first two notations, the first number represents the percentage discount that is to be given to the buyer upon completion of the incentive package.

The second number represents the number of days in which the discount package can be completed.

The third notation used is no more difficult than the first.

The only change occurs in the first character, the “n” is short for “net,” meaning that the net amount for the purchase is due on this date. In this case, the net amount is due 30 days from the date of the purchase.

Discount payment period, Discounted Payback Period

 

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