Credit terms: Overview, definition, and example
What are credit terms?
Credit terms refer to the conditions under which a seller extends credit to a buyer for the purchase of goods or services. These terms define the payment structure, including when payment is due, any discounts available for early payment, and the penalties for late payment. Credit terms help establish clear expectations for both the seller and the buyer regarding the timing and manner of payment for the goods or services provided.
For example, a supplier may offer credit terms that allow a buyer to pay for goods 30 days after delivery, with a 2% discount if the payment is made within 10 days.
Why are credit terms important?
Credit terms are important because they ensure that both parties understand their financial obligations and rights. For the seller, credit terms are a way to manage cash flow and reduce the risk of non-payment. For the buyer, they help manage finances by providing flexibility in payment. Clear credit terms can also encourage timely payments by offering discounts for early settlement or impose penalties for late payments. Overall, credit terms help create a structured and predictable financial relationship between buyers and sellers.
Understanding credit terms through an example
Let’s say a wholesaler provides goods to a retailer with credit terms of "2/10, net 30." This means that the retailer can receive a 2% discount if payment is made within 10 days of the invoice date. Otherwise, the full amount is due within 30 days, with no discount. This arrangement encourages prompt payment while providing flexibility to the retailer if they need more time to pay.
In another example, a service provider may offer credit terms of "net 60," meaning the client has 60 days from the date of the invoice to make the payment, without any early payment discounts or late fees.
An example of a credit terms clause
Here’s how a credit terms clause might appear in a contract:
“The Buyer shall pay the full amount of the invoice within 30 days of receipt of the goods. A discount of 2% shall be granted if the payment is made within 10 days of the invoice date. Any payment not made within the 30-day period shall be subject to a 5% late fee.”
Conclusion
Credit terms define the financial conditions under which goods or services are provided, offering a structure for payment timing, discounts, and penalties. For both buyers and sellers, clear credit terms help manage expectations and ensure a smooth transaction process. By specifying these terms in contracts, businesses can encourage timely payments, manage cash flow effectively, and reduce the risk of non-payment.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.