Payment terms: Types, examples, and how to set them up

Clear payment terms are the foundation of healthy business relationships. They establish when and how you expect to be paid, helping both parties avoid misunderstandings that can lead to tension or financial strain. Well-defined payment terms also protect your cash flow and set professional standards.

By communicating expectations up front, you demonstrate reliability and business acumen while giving customers the information they need to efficiently make payments.

Let’s break down common payment terms and their benefits, and explore how to establish terms that work for your business.

What are payment terms?

They outline things like the due date, accepted payment methods, and any discounts or penalties associated with early or late payments. You'll usually set payment terms in an agreement or invoice to ensure both parties are clear on the expectations.

Why setting payment terms is vital

Clear payment terms ensure timely compensation and establish professional boundaries, which can be especially important for small businesses. They also:

• Ensure predictable cash flow
• Help assess customer reliability and reduce financial risk
• Reduce payment delays
• Help customers plan their payments

Common types of payment terms

Here are some of the most commonly used invoice payment terms:

Net 30/60/90 terms are popular because, as they've become the industry standard, they're familiar to buyers, so they're more easily accepted. They also offer a compromise, giving the buyer time to pay in full while not straining the seller's cash flow management too much.

At the same time, cash in advance is a readily accepted payment term as it's how most people shop for most goods.

Other types of payment terms

Aside from the most common terms, you have several other options available to you:

• CBS (Cash Before Shipment): Payment is required before the goods are shipped
• CWO (Cash With Order): The customer pays at the time the order is placed
• Partial payment: A portion of the total amount is paid up front, with the balance due later
• Revolving credit: A credit agreement allowing customers to borrow and repay repeatedly up to a set limit
• Payment in arrears: Payment is made after the goods or services have been provided

The payment term you choose will come down to what works best for your business while also keeping customers happy.

How to set payment terms effectively in 8 steps

Choosing invoice payment terms requires balancing your cash flow needs with market norms. Here's how to create terms that protect your business while maintaining positive customer relationships.

1. Assess your cash flow needs

Before setting payment terms, analyze your business’s cash flow requirements. If you need faster cash turnover, shorter payment terms may be better for you. If you can afford to extend credit, offering longer payment periods might help attract and retain customers.

2. Research industry standards

Payment terms vary by industry, so it’s important to align with common practices to stay competitive. For example, net 30 and net 60 is a standard term in many industries, while cash-in-advance models are more common in high-risk transactions.

3. Evaluate customer payment history

Review your customers’ payment behavior and creditworthiness. Reliable customers who make timely payments may qualify for more flexible terms, while new or high-risk clients may require stricter conditions. Depending on your industry, you may consider running credit checks for added security.

4. Use contracts to protect your business

Draft legally binding contracts for larger transactions or long-term agreements to ensure payment obligations are clear. Well-defined terms protect your business and can be upheld in court if necessary. If a customer fails to meet the agreed terms, an enforceable contract allows you to take legal action to recover payments or seek damages.

5. Offer multiple payment methods

Various payment options, such as bank transfers, credit cards, and digital wallets, can encourage faster payments. Customers are more likely to pay on time when convenient payment options are available.

6. Automate invoicing and accounts receivable processes

Use invoicing software to streamline the payment process by automating invoice generation, monitoring due dates, and sending payment reminders. Automation tools also help manage accounts receivable (AR) efficiently by reducing manual errors and tracking outstanding payments.

7. Establish a follow-up process for late payments

Even with clear payment terms, some customers may delay payments. Build a structured follow-up process that includes reminder emails, phone calls, and, if necessary, late payment fees or collection procedures.

8. Review and adjust payment terms periodically

Business conditions, customer reliability, and market trends change over time. Regularly review your payment terms to ensure they remain aligned with your financial goals and customer needs.

When setting payment terms, it’s also important to ensure compliance with state and federal laws, especially regarding interest rates, late fees, and contract terms. Be sure you understand the Uniform Commercial Code (UCC) if you’re involved in the sale of goods, because it governs commercial transactions and payment disputes.

Automate bookkeeping with Ramp

Once you've set your payment terms, you need a way to manage your books that won't take up too much of your finance team's time. The best way to do that is with accounting automation.

Ramp simplifies bookkeeping with smart automation, helping finance teams streamline their workflows and reduce manual tasks. With Ramp, your team can:

• Expense management software: Eliminate manual expense reporting and enforce custom spending policies
• Business credit cards: Submit expenses effortlessly through SMS, mobile, and integrations while maintaining control over spending
• Accounts payable software: Manage 10X more invoices in half the time with OCR-powered automation for complex invoices and line items

Ramp also integrates seamlessly with QuickBooks, NetSuite, Xero, and other leading accounting platforms, ensuring your financial data stays accurate and up to date.

Get started with Ramp and take the manual work out of bookkeeping.