Skip to main content

Credit Terms – Definition, Types, Examples and Tips




Definition of Credit Terms

Credit terms are the payment terms mentioned on the invoice at the time of buying goods. It is an agreement between the buyer and seller about the timings and payment to be made for the goods bought on credit. It is also known as payment terms

Credit Terms in Invoice

Types of Credit Terms

  • Cash on Delivery (CoD): Here the payment is due at the same time as a product or service is delivered. This also known as ‘Payable on Receipt’

  • Payment in Advance: Seller demands the buyer to pay the consideration, either partial or full before the delivery of goods.

  • Pre-paid: This is exactly opposite of cash on delivery(COD). Here, the buyer is required to pay the full consideration for the seller before the delivery of goods.

  • Stage Payment: Payment of agreed amount upon completion of decided milestone.

  • Bill of Exchange: Arrangement to pay at a later date, usually with bank support.

  • N/10, N/15, etc: This is applicable in case of credit sales and it notifies the maximum credit period allowed for payment. Here, N/10 denotes the net credit period of 10 days.

  • 2/10, n/30: The credit term of [ 2/10, n/30] means that you will get a discount of 2% if you clear your account within 10 days with a maximum credit period of 30 days.

  • 2/10,n/30 E.O.M: Here E.O.M stands for ‘End of Month. This credit term of [ 2/10,n/30 O.M ] implies that you will get a discount of 2% if you pay your account within the first 10 days of next month with a maximum credit period of 30 days.

  • 2/10 R.O.M: Here R.O.M stands for Receipt of goods dating method. A credit term of [ 2/10 O.M] means that you will get a discount of 2% if you make the payment within the first 10 days after the goods are received.

Read What is Cash Discount? Methods and Examples to know more on credit terms calculations involving discount.

How much Credit to be Extended?

If you are finding it difficult to decide as how much of credit you can extend to your customer then this decision of yours has to be based on how much risk you are willing to take or get exposed to in the event of default in payment from the borrower. We call this as Credit exposure in business language.

For example, if you have sold 4 lakhs on credit, your credit exposure in the event of default will be Rs. 4 lakhs.

Here is why a formal credit policy will help your business. Your credit policy will define the credit limits you are willing to give your customers, i.e. the maximum amount of credit you can give to your customers.

Your policy should also need to outline the maximum credit period you want to give to your customers and the process your business will follow to approve credit terms, exceptions and the process for handling violations.

Factors Influencing Credit Terms

  • Time Factor

Here, the customer is allowed a time benefit and the seller expects the bill to be settled before the due date. Typically, the time limits are set before the transaction is made.

  • Credibility Factor

The credit you lend to your customer depends upon the creditworthiness of your customer. This could be based on the volume of transactions, the capacity of repayment, historical performance, etc.

  • Interest rate Factor

Depending on the amount and credit period, sellers do charge interest, either for the entire credit period or only for an overdue period.

Tips to Manage Credit Terms

Credit terms adopted by the businesses differ from each other and the credit you would lend to a customer could be totally different for another customer. There is no right or wrong about the type of credit terms applied by you. It’s all about what works better for your business, you and your customer.

Irrespective of the type of credit terms you choose, here are a few tips which will help you to be on top of credit sales.

  • Mention the Credit terms on the Invoice: It’s a good practice to mention the credit terms or terms of payment on the invoice to track the due date and also to notify the buyer about the same.

  • Find and Set the Credit Period for each customer: It’s recommended to identify the credit period for each customer based on the factors like products, volume, frequency etc. and set it as default credit period in your accounting software.

  • Credit Limit: Based on the creditworthiness and credibility of the customer, defining maximum credit limit which you can lend to a customer will help in avoiding the situation of overselling to the customer beyond the defined limit. This will be helpful especially when there are different people responsible for managing sales and accounts receivables.

  • Overdue Notification: if your credit policies disallow new sales to customer’s having overdue bills, having an internal alert system to notify the overdue bills during invoicing will help the business.

Find out How Tally.ERP 9 will help you in defining and managing credit terms?

Comments

Post a Comment

Popular posts from this blog

What are the Key Reports a Business Owner Must Track and Which is the Best Tool for it?

As a business owner, you must be already keeping a track of the overall financial health of the business. While you may hire an accountant for end-to-end tasks that will keep your books of accounts updated, it is imperative that as a business owner, you also go beyond the basic understanding of key financial reports to take your business to the next level. The three primary key aspects which would help you as a business owner to get a holistic view of your company’s books of accounts in sync with your business transactions are; Cash Stock and Taxation Cash What is the ultimate goal of any business? To have regular cash flow, right? So, where do we get these crucial insights about cash flow management in order to stay updated with your company’s finances from? Let’s take a look at how these cash flow reports will help you build your business and trigger long term, growth. Cash Flow Cash flow is the amount of money going in and out of your business. Healthy cash flow can help lead your b...
Post a Comment
Read more

Break Even Point: Definition, Formula, Example and Analysis

What is the Break-Even Point? A simple financial tool which helps you determine at what stage your company, or a new service or a product, will be profitable. To put simply, break-even point analysis will tell you the number of products or services a company should sell to cover its costs, particularly fixed costs. Break-even is a situation where you are neither making money nor losing money, but all your costs have been covered. Break-even analysis is useful in studying the relation between the variable cost, fixed cost and revenue. Generally, a company with low fixed costs will have a low break-even point of sale. For example, a company has a fixed cost of Rs.0 (zero) will automatically have broken even upon the first sale of its product. The purpose of the break-even analysis formula is to calculate the amount of sales that equates revenues to expenses and the amount of excess revenues, also known as profits, after the fixed and variable costs are met. The main thing to understand i...
Post a Comment
Read more

6 Tips for Efficient Cash Flow Management

By definition, cash flow refers to the amount of money flowing in and out of the business. The larger the time gap between cash outflow (payments to your supplier, employees, duties etc.) and cash inflow (receipts from your customers), the higher the risk it possesses to the business. These situations persist in every business and to smoothly manage such situations, you need cash flow management. In simple words, cash flow management largely implies managing frequency of payments and a whole lot of activities to encourage your customers to pay as fast as possible. Cash flow management involves a process of preparing cash flow statement, monitoring, analysing and optimizing such that business has enough cash cushion to run their business. In this article’ Tips to Efficient Cash Flow Management’, we are sharing you some of the best ways to manage optimum cash flow in your business. Here are 6 quick tips to manage your cash flow efficiently. Faster realisation of accounts receivables Acco...
Post a Comment
Read more