What are payment terms?

Definition

Payment terms are the due-date rules for settling an invoice. They say when the cash is due, and they may add a discount for paying early or a fee for paying late.

On the books, terms do not create a new account by themselves. They only set how long accounts receivable or accounts payable is allowed to sit open.

The clock usually starts on the invoice date. Some deals start it on delivery, on month-end, or on a stated date in the agreement.

Where it shows up

Balance Sheet: Related to how long receivables and payables sit open.

P&L: Related to nothing extra unless a later discount or late fee is recorded.

Cash flow: Related to when cash actually moves against those invoices.

See also: Net 30 · Invoice · Days Sales Outstanding

When you look at the Balance Sheet, you will not find a line named for the agreement. You will find receivables in current assets and payables in current liabilities that stay open for as long as the terms allow.

Shorter terms pull cash in sooner and keep the receivable smaller. Longer terms leave more money sitting with customers and push cash later on the Statement of Cash Flows.

The Income Statement usually ignores terms on the day the invoice is issued. Revenue was already earned, and only a later discount or late charge can hit profit after the fact.

Days sales outstanding is the practical scoreboard on the customer side. If invoices are labeled net 15 and this number sits at 45, customers are not paying on the terms you printed.

Days payable outstanding is the matching scoreboard for what you owe vendors. Terms you accept from suppliers set how long those bills can sit before they are late.

How it works

The seller and the customer agree on terms before goods go out, or the seller prints them on the invoice as the offer. Net 15, net 30, and due on receipt are the common labels.

"Net" means the full amount is due in that many days. Due on receipt means the invoice is payable as soon as it arrives.

Some terms add an early payment discount, such as 2 percent off if cash arrives in ten days. Some add a late fee if the due date is missed.

The invoice still creates the receivable on the day it is issued. Terms only decide the due date that aging and follow-up will use.

When cash arrives on time, the receivable is cleared and nothing extra hits the Income Statement. When cash arrives early and a discount is taken, the seller records a smaller collection and a discount against revenue.

When cash arrives late, the original invoice stays open until it is paid. A separate late charge is recorded only if the agreement actually allows one.

On the vendor side, the same labels appear on bills you receive. Your payable stays open until you pay, and the due date on that bill is the term you accepted.

Example

A florist sells bread to a neighborhood cafe every weekday. The florist prints net 15 on each cafe invoice, so the full amount is due 15 days after the invoice date.

Monday's $200 invoice is dated March 1. Under these terms it is due March 16.

The books already recorded the sale and the receivable on March 1. Nothing extra is journaled for the 15-day window itself.

If the cafe pays on March 10, cash comes in before the deadline and the receivable clears. If the cafe pays on March 30, the invoice is past due and cash from operations arrives later than the terms promised.

No journal is made for the terms line on the invoice. The journal is the original sale, and later the cash that pays it.

Common mix-ups

Payment terms are not the invoice. The invoice is the bill that creates the receivable, and the terms are only the due-date rules printed on it.

Payment terms are not cash. Printing net 15 does not move money, and cash moves only when the customer actually pays.

Payment terms are not a credit limit. A credit limit caps how much a customer may owe in total, and terms only say how fast each invoice should be paid.

Net 30 is one common set of terms, not a different kind of document. Many other windows exist, including net 15, net 45, and due on receipt.

Related terms

• Net 30: Payment terms requiring the full invoice to be paid within thirty days.
• Early Payment Discount: A price reduction offered for paying an invoice ahead of the due date.
• Late Fee: A charge added when an invoice is paid after its due date.
• Invoice: The document that bills a customer and creates a receivable.
• Days Sales Outstanding: The average number of days it takes to collect an invoice.
• Days Payable Outstanding: The average number of days the business takes to pay its vendors.
• Credit Limit: The maximum balance a customer is allowed to carry on account.
• Collections: The process of following up on unpaid customer invoices.