Payment Terms and Financing
The Economics of Payment Terms
Payment terms are a pricing element often overlooked. Extending credit has real costs; accelerating payment has real value. Understanding these economics enables better decisions.
The Cost of Extended Terms
When you extend payment terms—say, from 30 days to 60 days—you're essentially lending money to your customer. That loan has a cost: your cost of capital applied to the invoice amount for the extended period.
Consider: Net 30 vs. Net 60 on a $10,000 invoice. If your cost of capital is 8% annually, the 30 extra days cost you: $10,000 × 8% × (30/365) = $65.75. On a 25% gross margin product, that $65.75 represents 2.6% of your $2,500 margin—a meaningful erosion.
This math matters when negotiating terms. If a customer wants extended terms, quantify the cost and either adjust price to compensate or trade for something of equivalent value.
Early Payment Discounts
Early payment discounts (e.g., '2/10 Net 30'—2% discount if paid within 10 days, otherwise full amount due in 30 days) accelerate cash flow and reduce credit risk. But they're expensive if you don't calculate the effective interest rate.
The annualized cost of a 2/10 Net 30 discount: The customer saves 2% by paying 20 days early. Annualized: (2% / 98%) × (365 / 20) = 37.2%. You're paying 37% annual interest to get cash 20 days early.
Compare this to your actual cost of capital. If you can borrow at 8%, the early payment discount is extremely expensive financing. Reserve early payment discounts for situations where cash is truly critical or credit risk is significant.
Financing as Value Creation
For large capital purchases, financing can be a powerful pricing tool—not a concession but a value-added service.
Customer benefits: Convert capital expenditure to operating expense, preserve credit lines, match payment to value received over time. Seller benefits: Overcome budget objections, capture financing margin, create stickier customer relationships.
Financing options include direct financing (you provide the loan, capturing interest income), third-party financing (partner with a finance company, receiving referral fees or better conversion), lease arrangements (customer uses equipment without ownership, you retain asset), and subscription/payment plans (spread payments over time with automatic renewal).
Key Takeaways
- Payment terms have real economic value—quantify the cost of extended terms
- Early payment discounts are expensive financing—calculate annualized cost before offering
- Financing transforms capital purchases into operating expenses, overcoming budget barriers
- Structure financing to create value for customers while generating returns for you