Credit Terms and Pricing: Net Terms, Discounts, and Risk Trade-offs in Receivables

1) Decoding Credit Term Language and Timelines (with Calendar Examples)

Credit terms are a compact way to specify when payment is due, whether discounts apply, and sometimes how the due date is anchored (invoice date, month-end, shipment date, etc.). Small wording differences can shift cash timing by weeks.

Common term formats

• Net 30 / Net 60 / Net 90: Full invoice amount is due 30/60/90 days after the reference date (usually invoice date unless stated otherwise).
• EOM (End of Month): Due at month-end or a set number of days after month-end. Often written as Net 30 EOM or Net EOM.
• 2/10 Net 30: A 2% discount is available if paid within 10 days; otherwise the full amount is due in 30 days.
• COD / CIA (less common in B2B credit terms discussions but important): Cash on delivery / cash in advance (effectively no receivables exposure).

Build a timeline: the practical decoding method

Use this step-by-step approach whenever you see terms on a contract or invoice:

1. Identify the anchor date: invoice date, shipment date, delivery date, or month-end. If not explicit, confirm with the customer and document it.
2. Mark the discount window (if any): e.g., “10 days” in 2/10 Net 30.
3. Mark the final due date: e.g., “30 days” in Net 30.
4. Translate to calendar dates: write the actual dates for the specific invoice.
5. Check for non-business-day rules: some contracts move due dates to the next business day; others do not.

Calendar examples

Why EOM matters: EOM terms can create large swings in effective days-to-pay depending on when in the month you invoice. If you invoice on the 2nd under Net 30 EOM, you may wait almost 60 days; if you invoice on the 28th, you may wait just over 30 days.

2) Early-Payment Discounts: An Implicit Cost/Benefit Decision

Early-payment discounts are a pricing lever that trades margin for faster cash. The key is to evaluate them like an investment decision: what “rate” are you paying (via discount) to accelerate cash?

Customer view vs. seller view

• Customer view: “If I pay early, I earn a risk-free return equal to the discount.”
• Seller view: “If I offer the discount, I’m paying a financing cost (lost revenue) to reduce days outstanding and lower credit exposure.”

Compute the implied annualized rate (the customer’s return)

For terms d/D Net N (e.g., 2/10 Net 30):

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Implied annual rate ≈ (Discount % / (1 - Discount %)) × (365 / (N - D))

Example: 2/10 Net 30

• Discount = 2% = 0.02
• Discount period D = 10 days
• Net period N = 30 days
• Time gained = 20 days

Implied annual rate ≈ (0.02 / 0.98) × (365 / 20) ≈ 0.020408 × 18.25 ≈ 37.2%

Interpretation: a customer that can borrow below ~37% annualized should rationally take the discount (ignoring operational frictions). That’s why well-designed discounts can materially pull cash forward—if customers are operationally able to pay early.

Seller decision: compare discount cost vs. cash benefit

Step-by-step evaluation for the seller:

1. Estimate adoption rate: what % of invoices will actually be paid within the discount window?
2. Quantify cash acceleration: how many days earlier will those payments arrive (e.g., 20 days earlier for 2/10 Net 30)?
3. Compute discount cost: discount % × revenue on invoices that take the discount.
4. Estimate financing benefit: accelerated cash × your short-term funding rate (or opportunity cost of cash) × days saved.
5. Add risk and operational effects: lower bad-debt risk, fewer collections touches, potential for higher customer satisfaction.

Simple numeric illustration (one invoice):

• Invoice amount: $100,000
• Terms: 2/10 Net 30
• Customer takes discount and pays in 10 days instead of 30 (20 days earlier)
• Your short-term cost of funds: 10% annual

• Discount cost: 2% × $100,000 = $2,000
• Financing benefit: $100,000 × 10% × (20/365) ≈ $548

On financing alone, the discount “costs” more than it saves. But the decision can still be rational if it meaningfully reduces credit losses, improves capacity to buy inventory, avoids covenant pressure, or reduces the need for external borrowing at higher marginal rates.

Operational reality: discounts only work if you can invoice cleanly

Customers often miss discounts due to disputes, missing PO numbers, incorrect tax/shipping, or slow invoice delivery. If you plan to use discounts as a cash lever, pair them with:

• Fast, accurate invoicing (same day as shipment/service completion)
• Clear remittance instructions and automated payment options
• Rapid dispute resolution so invoices are “payable” within the discount window

3) Linking Credit Terms to Pricing, Churn, and Competitiveness

Credit terms are part of the commercial offer, just like list price, rebates, and service levels. Two suppliers with the same nominal price can be very different economically to a customer if one offers longer terms.

Terms as a pricing component

Longer terms effectively provide financing to the customer. In competitive markets, customers may treat that financing as a price concession.

• Example: Supplier A offers $100/unit Net 30. Supplier B offers $100/unit Net 90. Even at the same unit price, Supplier B may win if the customer values the extra 60 days of cash retention.

Practical implication: if Sales requests longer terms to win a deal, Finance should ask whether the company is also adjusting price to compensate for the financing value and risk.

Terms and churn (retention) dynamics

• Stickiness: Generous terms can reduce churn because switching suppliers may require the customer to give up favorable payment timing.
• Adverse selection risk: The customers who push hardest for longer terms may be the ones with tighter liquidity or higher risk.
• Service expectations: Customers on long terms may still expect premium service; if margins are not adjusted, profitability can erode.

Competitiveness: matching the market without giving away the bank

A practical way to stay competitive while protecting cash is to separate customers into term tiers:

• Standard terms (default): e.g., Net 30
• Preferred terms (earned): e.g., Net 45/60 for customers with strong payment history and scale
• Promotional terms (time-bound): e.g., Net 60 for first 3 orders, then revert to Net 30

Time-bound terms are especially useful: they support acquisition while preventing permanent DSO creep.

4) Basic Credit Risk Controls That Protect Cash

Changing terms changes not only timing but also exposure: the longer you wait to be paid, the more you are financing the customer and the more time there is for something to go wrong (disputes, liquidity events, fraud).

Core controls

• Credit limits: a cap on outstanding exposure (open invoices + unbilled orders, depending on policy). Limits prevent a single customer from consuming disproportionate working capital.
• Approvals and exception workflow: who can grant Net 60/90, who can override limits, and what documentation is required (financials, payment history, deal rationale).
• Collateral: assets pledged to secure payment (more common in asset-heavy contexts). Collateral can reduce loss given default.
• Guarantees: personal guarantees (for smaller businesses) or parent-company guarantees (for subsidiaries). These can materially improve recoverability.
• Security interests / retention of title: contractual rights over goods until paid (jurisdiction-dependent). Useful where enforceable.

How controls connect to day-to-day order flow

Controls must be embedded in the order-to-cash process so they actually protect cash. A practical implementation pattern:

1. Set an initial limit and terms at onboarding based on available information (trade references, financial statements, external data, or internal scoring).
2. Define “available credit” as limit minus current exposure (open AR + open orders if policy includes them).
3. At order entry, check available credit automatically.
4. If exceeded, route to an approval queue with clear options: reduce order, request prepayment, split shipment, obtain guarantee, or approve exception.
5. Review limits periodically (e.g., quarterly) and dynamically when behavior changes (late payments, disputes spike, negative news).

Designing limits to match terms

Longer terms typically require higher limits to avoid constant order holds. That is exactly why term changes should trigger a credit review.

• Example: A customer buying $200k/month on Net 30 might peak at ~$200k–$300k outstanding depending on billing cadence. On Net 90, the same customer could build to ~$600k–$800k outstanding. If you extend terms without raising limits, you will create operational friction; if you raise limits without controls, you increase risk.

5) Decision Scenarios: Margin vs. DSO When Loosening Terms to Win Sales

When Sales proposes looser terms, the decision should be framed as a trade-off between incremental gross profit and incremental working capital tied up (plus risk). Below are practical scenarios you can use in deal reviews.

Scenario A: Net 30 to Net 60 to win incremental volume

Current state:

• Annual revenue with customer: $2,400,000 ($200,000/month)
• Gross margin: 30%
• Terms: Net 30
• Assume DSO roughly tracks terms for this customer

Proposal: Move to Net 60 and win +$50,000/month additional sales (=$600,000/year). Margin stays 30%.

Step-by-step evaluation:

1. Incremental gross profit: $600,000 × 30% = $180,000/year
2. Incremental AR investment from extra sales at Net 60: $50,000/month × (60/30) ≈ $100,000 average AR tied to the incremental stream (rule-of-thumb: average AR ≈ monthly sales × (DSO/30))
3. Incremental AR investment from extending terms on existing sales: existing $200,000/month shifts from ~30 to ~60 days, adding ≈ $200,000 average AR
4. Total incremental AR: ≈ $300,000
5. Financing cost of incremental AR: $300,000 × 10% = $30,000/year (using 10% cost of funds as an example)

Interpretation: If risk is unchanged, the margin gain ($180k) comfortably covers the financing cost ($30k). But you still need to test whether risk is truly unchanged and whether operationally the customer will pay in 60 days or drift beyond it.

Scenario B: Net 30 to Net 90 with price concession vs. without

Base: $300,000/month revenue, 25% gross margin, Net 30.

Option 1 (terms only): Move to Net 90, no price change, expected to prevent churn (retain the account).

• Incremental AR from term extension: $300,000/month × ((90-30)/30) = $600,000 additional average AR
• Financing cost at 12%: $600,000 × 12% = $72,000/year

If the account would otherwise churn, compare $72k/year to the gross profit you would lose by churn:

• Annual gross profit at risk: ($300,000 × 12) × 25% = $900,000/year

In that case, Net 90 may be economically justified as a retention tool—if credit risk remains acceptable.

Option 2 (terms + price adjustment): Move to Net 90 but increase price by 1.5% to offset financing and risk.

• Annual revenue: $3,600,000
• Price uplift value: 1.5% × $3,600,000 = $54,000/year

This doesn’t fully cover the $72k financing cost in the example, but it narrows the gap and can be combined with risk controls (lower limit, guarantee, or discount for early pay) to balance the economics.

Scenario C: Offer 2/10 Net 30 instead of Net 60

Sometimes the goal is faster cash, but Sales believes customers need flexibility. A discount can be a targeted alternative to blanket term extension.

Setup: $150,000/month revenue, current Net 30. Sales proposes Net 60 to match competitors. Finance proposes keeping Net 30 but adding 2/10 Net 30.

Assumptions:

• Under Net 60, expected DSO becomes 60.
• Under 2/10 Net 30, 50% of invoices take the discount and pay on day 10; the rest pay on day 30.

Compute expected DSO under discount option:

Expected DSO = 0.5×10 + 0.5×30 = 20 days

Working capital comparison (rule-of-thumb average AR):

• Net 60 AR ≈ $150,000 × (60/30) = $300,000
• Discount option AR ≈ $150,000 × (20/30) = $100,000
• Difference: $200,000 less AR tied up under the discount option

But discount cost:

• Discounted portion per year: $150,000 × 12 × 50% = $900,000
• Discount cost: 2% × $900,000 = $18,000/year

This frames a clear trade: pay $18k/year in discounts to potentially reduce average AR by ~$200k (plus reduce exposure duration). Whether that is attractive depends on your funding cost, risk, and strategic value of matching competitor terms.

Scenario D: Loosen terms to win a deal, but protect cash with controls

Deal request: New customer wants Net 90 for a $1,000,000 annual contract at 35% margin.

Risk-aware structure:

• Start with Net 30 for first 2 invoices, then step up to Net 60, then Net 90 only after on-time payment history.
• Set a credit limit that caps exposure (e.g., $250k) and require partial shipments or milestone billing to stay within it.
• Require a parent guarantee or letter of credit if the customer is a subsidiary or has limited financial transparency.
• Offer 1/10 Net 90 (or similar) to encourage early pay without forcing it.

This approach acknowledges commercial reality (customer wants long terms) while preventing uncontrolled exposure growth during the riskiest phase (early relationship).

A simple deal-review checklist (terms and pricing together)

• What is the exact term language and anchor date?
• What DSO do we realistically expect (not just what the contract says)?
• How much additional average AR will this create?
• What is the incremental gross profit, and does it cover financing cost plus expected credit loss?
• Are we adjusting price (or offering discounts) to reflect financing value?
• What controls (limit, approvals, guarantee/collateral) are required before shipping?
• Is the term change time-bound or permanent?