Payment terms are the rules imposed by suppliers on their customers to ensure that payment for the goods or services provided is received within an agreed time frame. Payment terms range in their length but are generally between 30-60 days. To encourage a customer to pay earlier, a supplier may offer a settlement discount from the total invoice value for quicker payment.
From the customer’s perspective, taking advantage of discount terms such as this can be beneficial. For example, if a customer on 30 day terms pays within 10 days, they may receive 2% off the entire order value, but face 20 days with lower cash holdings. To deal with this issue, a customer should assess the value of the discount against the cost of borrowing cash. If money can be borrowed at a lower rate than the discount received, there is a strong argument that the invoice should be paid early. In addition, if the customer has sufficient cash holdings to pay the invoice early and receive the settlement discount this may make sound commercial sense. This is of course on the basis that making the payment early doesn’t deplete cash resources to dangerously low levels.
From the supplier’s perspective, they are looking to create payment terms that result in them receiving payment as quickly as possible such that they may continue to produce goods or services and pay costs. They may offer a discount to encourage early payment in an effort to maintain a healthy cashflow.
Over recent years larger organisations have been using the lever of their significant purchasing power to extend payment terms to their smaller suppliers beyond all reasonable levels. This has often been done with little or no notice to the supplier.