The credit period is the number of days that a customer is allowed to wait before paying an invoice. The concept is important because it indicates the amount of working capital that a business is willing to invest in its accounts receivable in order to generate sales. Thus, a longer credit period equates to a larger investment in receivables. The measure can also be compared to the credit period of competitors, to see if other companies are offering different terms to their customers. For example:
- If the company grants terms of 2/10 net 30, this means the credit period is 10 days if the customer chooses to take a 2% early payment discount, or the credit period is 30 days if the customer chooses to pay the full amount of the invoice.
- If the company grants terms of 1/5 net 45, this means the credit period is 5 days if the customer chooses to take a 1% early payment discount, or the credit period is 45 days if the customer chooses to pay the full amount of the invoice.
The credit period does not refer to the amount of time that the customer takes to pay an invoice, but rather to the period granted by the seller in which to pay the invoice. Thus, if the seller allows 30 days in which to pay and the customer pays in 40 days, the credit period was only 30 days.
If the seller is requiring multiple payments over time, the credit period is the interval from when credit is first extended until the last payment is supposed to be made by the customer. Thus, if the seller allows for three monthly partial payments, with the last payment due in 90 days, the credit period is 90 days.
An entirely different concept is the collection period, which is the actual amount of time it takes for the seller to obtain payment from the buyer. Depending on the credit quality of the buyer, the collection period can be substantially longer than the credit period.
When a company requires cash-on-delivery terms, the credit period is zero days, and the collection period is also zero days.