When deciding the payment terms of your small business there’s something you should know: extend your payment terms for too long and you could jeopardize your business’s future.
Why is that true?
Depending on the industry, you could be paid in days or months. For example, restaurant owners are typically paid in 1-2 days whereas construction companies may not receive funds for up to 90 days. That may be okay for large companies that can afford to extend payment terms for their clients, but a lack of cash flow for small businesses could cause them to fail.
In this post, we’ll help answer a very important question that all small business owners have:
What determines whether your payment terms are fair and reasonable and how do you decide?
Tips to Decide the Payment Terms for Your Business
These simple tips are very helpful when deciding your payment terms:
- Check each client’s credit history (pull a business credit report if you can). For clients that don’t pay their bills in a timely manner, you can ask them to pay in full in advance or give you a down payment. If that’s not agreeable, you may want to conduct business with customers with better credit histories.
- Gear payment terms to the amount of the invoice. It makes sense to give customers more time to pay a larger invoice.
- Set clear terms and fees in every contract and your invoices so there’s no confusion as to when you expect payment.
- Consider adding late fees and offering early payment discounts as incentives for clients to pay their bills quicker.
- Read these articles for further advice on how to manage accounts receivable and cash flow.
How Do You Decide the Payment Terms for Your Business?
When you provide a good or service, your goal is to receive payment as soon as possible.
The industry standard for payment is NET 30 which means the customer pays their bill within 30 days after receiving an invoice. To speed up payment, some small business owners choose payment terms of NET 15, NET 7, or cash on delivery or COD (which means getting paid immediately).
If the payment is required immediately or if the credit period is too short, you run the risk that your customer switches to another supplier.
In order to choose a payment term that provides a steady stream of working capital, it’s important to know the average for your industry. Review the following common industries and you’ll notice payment terms vary widely.
Consult this dictionary of the most common invoice payment terms
Average Payment Terms Benchmarks for 12 Industries
Average payment terms: Up to 90 days, maybe more
- Payments made to subcontractors who work in the construction industry are often delayed. A recent study titled Construction Payments Report 2018 published by Rabbet, a construction finance platform found that 88% of contractors have to wait for more than 30 days to receive their money. Another 46% can expect delays of between 60 and 90 days.
- Not receiving funds on time results in considerable costs. According to the study, contractors incur an estimated $40 billion annually in expenses connected with slow payment receipts.
Average payment terms: 37 days
- Although the average number of days within which a trucking company receives payment is 37, the period could vary widely. For example, in 2017, Proctor & Gamble, a giant consumer goods corporation, announced a change in its payment terms. It revised the number of days within which it pays its shippers from 75 to 120. Kellogg Company, a large food manufacturing corporation, implemented a 120-day payment policy in 2014.
- Delays in receiving the sums due to them can put an enormous strain on shippers as they need to make regular payments for drivers’ wages, fuel bills, and the monthly instalments on their trucks.
Foundation, structure, and building exterior contractors
Average payment terms: 68 days
- The Sageworks study mentioned above found that contractors who provide foundation, structure, and building exteriors usually have to wait for over two months to receive the payment due to them. This could put a strain on their finances. In most instances, contractors who work in this segment access external sources of funds to meet their day-to-day needs.
Average payment terms: Immediate to 30-90 days
- If you run an auto repair shop, you would expect most customers to pay as soon as the work on their cars is complete. But the bill could run into thousands of dollars, and some clients may not be able to afford to pay the entire sum immediately. If you know the customer well, it may be a good idea to offer an affordable monthly payment plan. This would ensure that you get more business. Of course, you should provide the credit only if you are sure that you will receive your payments on the promised dates.
- Another good option is to tie up with a bank or a finance company to offer a loan to a customer. If you do this, you will get your money immediately and your customer will be able to pay in instalments.
Average payment terms: Immediate to 14 days
- This industry has a particularity: although there are one-off customers, services tend to be ongoing.
- If it’s a one-off, you might want to ask for a deposit before the work starts and the rest when it’s completed, especially if it’s a big job and you need to buy specific products.
- If it’s an ongoing contract, just receiving the payments on a specific date each month will be enough. Maybe even you can get paid twice a month, depending on the scope of the business.
Average payment terms: Immediate to a week
- Usually, this industry doesn’t have a problem receiving payments quickly.
- When it comes to larger jobs, many landscaping businesses ask customers for part of the payment as a deposit before they start working. This could be a percentage of the total (depending on how much the total is) before starting, percentages that are paid upon milestones or just the price of materials.
Food and beverage
Average payment terms: Immediate to 3 days
- If you run a restaurant, a significant portion of your sales will be by cash. This will help to improve your liquidity and give you the funds that you need to pay your suppliers and meet your other expenses.
- Sales made against credit or debit cards will result in a slight delay in payments. But in most instances, you’ll receive the money that is due to you within a few days. Here’s a post that explains how long it takes for a merchant to obtain funds when a sale is made by card.
Average payment terms: Immediate to 3 days. More if you offer store credit.
A large portion of retailers’ sales is usually by cash or card. So, most payments would be received within three days.
But what if you offer store credit? This is essentially a sales promotion tool, and it could result in higher revenues for your business. However, it comes with its share of problems. You will have to:
- Devise a credit policy. Which customers will you offer credit to?
- Set credit limits and a period within which payments will become due.
- Arrange for the funds that you will need to buy new merchandise. Remember that your customer may pay you only after 30, 60, or 90 days.
- Review your financial data to see whether offering credit helps to increase your profitability. If you provide credit, your interest costs could go up, and you could lose money if a customer fails to pay.
Average payment terms: Immediate to 3 days
- For most small farmers who sell their produce directly to consumers, getting payments quickly isn’t a problem. They receive their sale proceeds in cash or are paid by card. Consequently, they get their payment immediately or within three days.
Leisure and hospitality
Average payment terms: Immediate to 3 days
- In the leisure and hospitality industry, payments are made by cash or card. The amount that is due would be received immediately or within a matter of days. However, credit card fraud could be a worry. If a hotel guest pays with a stolen card, the issuer may be unwilling to bear the loss. Hotels can reduce this risk by asking the guest to provide a photo identity at the time of payment.
Average payment terms: 74 days
- If you provide professional services to clients, it’s best to negotiate payment terms at the time that you enter into the contract. A crediting period of 30 to 60 days is usually sufficient. However, you may have to wait longer than that to get your money. A survey conducted by Sageworks, a financial information company, found that firms that provide architectural, engineering, and related services received payments in an average of 74.4 days.
Real estate broker
Average payment terms: Immediate
- Real estate brokers receive the amount due to them upon completion of the transaction. However, sale or purchase deals, or even a rental, could take weeks to complete.
Use This Formula to Calculate the Average Period Collection
Do you want to have a good idea of the average number of days it takes clients to pay their bills in your business? By using the simple formula below, you can know if the payment term you intend to use is realistic for both you and the client.
Average Period Collection = (Average Accounts Receivable / Net Credit Sales) x Number of Days in Period
Average Period Collection Formula: an example
Here’s an example using yearly figures:
Imagine your average accounts receivable is $20,000 and net sales for the year are $200,000.
Average Period Collection = ($20,000 / $200,000) x 365
Average Period Collection = 36.5 days
You can figure your average accounts receivable by adding your beginning and ending AR balances for a designated period (month, year, etc.) and divide that total by 2.
Get a Small Business Loan to Improve Cash Flow
Once you settle on payment terms for your business according to what’s reasonable for your industry, make sure to note your terms on contracts, purchase orders, and invoices. Don’t forget to list late payment fees or discounts for early payments.
When cash flow is lower than normal, a small business loan can provide needed funds. At Camino Financial, we work with clients from a wide variety of industries and match them with the best loan for their businesses.
You can fill out a simple application online from the comfort of your home or office and receive funding within 4-10 business days. No collateral is required and Camino Financial has limited restrictions on fund usage.
Why not contact us today so we can help you achieve long-term financial success?