Account Receivables

Terms of Trade

Credit terms are often quoted as "net X," with X being a certain number of days. An example of a common payment term is Net 30, which means payment is due at the end of 30 days from the date the invoice is issued. Transit time is included when counting the days, i.e., a purchase in transit for 7 days before receipt has just 23 additional days until payment is due from the seller.

Other common payment terms include Net 45, Net 60, and 30 days at the end of the month. Net 30 is a term that most businesses and municipalities (federal, state, and local) use in the United States. Net 10 and Net 15 are also widely used. Net 60 is less used because of its longer payment terms.

The debtor is free to pay before the due date, and some businesses offer a discount for early payment. A discount can be offered and stated as "2/10, net 30."

This means the buying firm will receive a two percent discount if it pays by the tenth day. Otherwise, they will pay the full amount in 30 days.

Let's consider a potential case of the operator of an ice cream stand. The operator may sign a franchising agreement, under which the distributor agrees to provide ice cream stock under the terms "Net 60" with a ten percent discount on payment within 30 days and a 20% discount on payment within 10 days.

This means the operator has 60 days to pay the invoice in full. If sales are good within the first week, the operator may be able to send a check for all or part of the invoice and make an extra 20% on the ice cream sold. However, if sales are slow, leading to a month of low cash flow, then the operator may decide to pay within 30 days, obtaining a 10% discount, or use the money another 30 days and pay the full invoice amount within 60 days.

The ice cream distributor can do the same thing, receiving trade credit from milk and sugar suppliers on terms of Net 30, a 2% discount if paid within ten days. Under this agreement, they are apparently taking a loss or disadvantageous position in this web of trade credit balances.

Why would they do this? First, they have a substantial markup on the ingredients and other production costs of the ice cream they sell to the operator. The markup is the portion of the selling price added to the cost of obtaining the inventory. In addition, it is not in the distributor's best interest for customers to go out of business due to cash flow instabilities, so its financial terms aim:

Markup This equation shows the selling price for a vendor calculated by adding its markup to its cost.

1. Allow start-ups the ability to manage their inventory investments – effectively giving them a short-term business loan.
   
   
2. By tracking which customers pay and when, the distributor can identify developing problems and take steps to reduce or increase its trade credit.