Payment Terms During Economic Growth vs. Downturn

5 min read

Executive Summary

As a small business owner, there is a lot at stake when you choose your invoice payment terms. Payment terms not only determine how and when you will be paid but also sets the tone in the financial relationship between you and your customers. However, there isn’t a one-size-fits-all approach to invoicing. The best invoice payment terms are the ones that ensure positive and consistent cash flow to keep your business running while satisfying your customers’ needs and expectations.

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In order to find the right invoice terms for your business, knowledge of payment terms, and practices within and across industries will aid your decision making.

What are payment terms?

Payment terms are the conditions surrounding the payment part of the sale. This can refer to a broad range of transaction details such as when the payment should be made, but also how and under what conditions. It can also include other elements of a sale such as discounts for early payment to incentivize the customer to make the payment before the due date.

These payment terms are typically specified by the seller to the buyer and businesses may choose to even arrange special payment terms with different customers.

Typical terms by industry

Among small businesses, the standard invoice term is known as Net 30. This simply means that the payment for goods and services is due in full within 30 days of receiving the invoice. Net 30 is different from ‘due in 30 days’; the former is a credit term where customers can have a discount on the goods and services if they pay earlier before the 30 days are up and the latter indicates that payment is due 30 days after the invoice is received.

Invoice Terms Types of Industries
Net 30 Consumer and Manufacturing
Net 30 to Net 60 Fashion and Construction
Terms vary widely Freelance

Invoice terms may vary significantly across industries but small businesses generally fall into three categories. First, a business may follow industry practice and offer the same payment terms as businesses in the same or similar industries. For instance, the standard invoicing term across manufacturers of tangible consumer goods is set at Net 30. Secondly, businesses may offer a range of payment terms, depending on the existing relationship between supplier and customer. This is practiced in the fashion and construction industries where terms can range from Net 30 to Net 60. Lastly, payment terms may vary widely for businesses in the same industry and a good example would be the freelance industry. Freelancers may follow their own prerogative to negotiate and decide if they require up-front payment or if they are willing to be paid in 60 days or more.

The general rule of invoicing is to try and get paid as soon as you can. However, it is risky if you deviate too far from the invoicing norms in your industry. As mentioned, the standard invoice terms among small businesses is Net 30. Although you may be tempted to set Cash on Delivery terms to get paid faster, you may encounter pushback and risk alienating your customers. For instance, you may only want to consider upfront payment from brand new clients, as opposed to customers with good payment history, to reduce the risk of non-payment. Additionally, you may want to provide a longer deadline for clients with a larger invoice so they may have sufficient time to go through internal approval processes and gather the money necessary to pay.

Payment practices in the US

According to Dun & Bradstreet’s Payment Study in 2020, 54.9% of US companies were reported to have paid on-time while a further 38.2% paid up to 30 days late on average. The financial services sector had the highest concentration of punctual payments (65.7%), followed by the agricultural, forestry, hunting, and fishing sector (63.7%) and thereby the services sector (58.3%).

The study also investigated the relationship between punctual payments and firm size and found that large firms, with more than 260 employees,  have the highest likelihood for late payment.  According to the data, there is a correlation between late payment and firm size.

Type of Company Paid by Due Date Paid Over 90 Days Late
(5 employees)
60.0% 2.9%

(> 5 and 50 employees)

48.5% 2.8%

(>50 and 260 employees)

26.7% 1.6%

(> 260 employees)

13.2% 0.7%

In response to the finding that the percentage of good payers decreases as company size increases, the report suggests that it could be that larger companies can exert more control over their terms and may be less sensitive to fluctuations in creditworthiness.

Unfortunately, this is in line with existing research that found late payment of trade debts to be associated with the relative power positions of suppliers and customers, especially if the customer is in a monopolistic or oligopolistic position in the market.

What is to be done?

The supply of trade credit by small businesses caters to customer demand and offers strategic advantage but is, ultimately, subject to risk. The time lag between sales and payment may give birth to late payment delinquency or default risks in the form of bad debts. In the current economic downturn, you may be keen to offer generous invoice terms to win business but this increases your risk exposure. It is duly important to note that research has found evidence that late payment problems are one of the primary causes of small business failure.

As such, firms should aim to prevent rather than cure the problem of late payment by proactively negotiating, using credit information for risk-screening, and implementing clear payment policies. In order to incentivize early payment, you may consider an early payment discount. For example, if a customer pays you within 10 days on a Net 30 invoice, you might give them a 2% discount. Additionally, you may consider adding late fees or interest charges to your invoice terms so as to enforce your payment expectations. It’s generally customary to charge 1.5% to 2% of the invoice amount as interest for late payment. It’s also worthwhile to ensure you bill promptly and follow-up on late payments by sending a friendly reminder email to your clients.

With early or on-time payments, the time scale of the cash conversion cycle will shorten and thereby improve your business cash flow in the short-term,  help optimize working capital in the medium term and sustain your business for the long-term.

About the author

Ken So

Written by Ken So

Ken is the Founder and CEO of Flowcast and Tillful. Having spent most of his career before Tillful in tech and investment banking, he covers all things business credit and finance with a twist of insider knowledge.

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