Accounting payment terms are the payment rules imposed by suppliers on their customers. Payment terms are imposed to ensure that payments are received by suppliers within a reasonable period of time. Discount terms may be allowed in order to accelerate cash collections. A large customer may use its purchasing power to force a supplier to agree to terms that are more favorable to the customer, such as a longer period of time in which to pay the supplier, or relaxed rules for returning goods. There are three possible components to accounting payment terms, which are:
Discount terms. This is a two-part statement, where the first item is the percentage discount allowed, and the second item is the number of days within which payment can be made in order to receive the discount. Thus, terms of "1/10" mean that a discount of 1% can be taken if payment is made within 10 days.
Net terms. "Net" means that the full amount is due for payment. Thus, terms of "net 20" mean that full payment is due in 20 days. The term may be abbreviated to "n" instead of "net".
End of month terms. The abbreviation "EOM" means that the payer must issue payment within a certain number of days following the end of the month. Thus, terms of "net 10 EOM" mean that payment must be made in full within 10 days following the end of the month.
The following table contains a number of standard accounting payment terms, what they mean, and the effective annual interest rate being offered (if any).
|Net 10||Pay in 10 days||None|
|Net 30||Pay in 30 days||None|
|Net EOM 10||Pay within 10 days of month-end||None|
|1/10 Net 30||Take 1% discount if pay in 10 days, otherwise pay in 30 days||18.2%|
|2/10 Net 30||Take 2% discount if pay in 10 days, otherwise pay in 30 days||36.7%|
|1/10 Net 60||Take 1% discount if pay in 10 days, otherwise pay in 60 days||7.3%|
|2/10 Net 60||Take 2% discount if pay in 10 days, otherwise pay in 60 days||14.7%|
The effective interest rate stated in the preceding table is based on the following calculation:
Discount %/(1-Discount %) x (360/(Full allowed payment days - Discount days)) = Effective interest rate
A customer's continuing non-compliance with payment terms may lead to a supplier's decision to stop offering credit terms to that customer.