Definition of Credit Terms
Credit terms refer to the conditions agreed between the buyer and the seller as a part of the agreement regarding the payment for the goods and services transferred. The terms provide for the time the buyer shall pay the seller and any other condition related to such a credit period extended.
Explanation
Companies usually enter into agreements with their customers and vendors. Depending on the credit policy agreed with the other party; the agreement defines the credit terms, which specify the timeframe within which payments must be made. These terms outline the consequences of late payments, including potential penalties. Additionally, conditions may be specified for early payment discounts, designed to incentivize prompt payment. The duration of the credit period agreed upon by the parties can vary, typically ranging from 30 days to 60 days or more.
Example of Credit Terms
The credit terms agreed between the buyer and seller as described as follows:
“Term 3/10 net 30”
This implies that the credit period extended by the seller to the buyer is “30 days”. Further, if the payment is made within a period of “10 days”, then a discount @ “3%” is to be allowed to the buyer.
Types of Credit Terms
You can find the following types in the agreements:
- Net 10
- Net 30
- Net 60
- Net 90, and so on.
Further, the terms may also provide for discounts if the payment is made within a given number of days, such as “Term 3/10 30”.
Credit Terms and Conditions
Credit terms and conditions include the following elements:
- Credit Period: The credit period represents the maximum time period allowed to the buyer to make the payment, such as 30 days, 45 days, 60 days, and so on.
- Credit Limit Allowed: There might be a monthly or an overall limit on the amount of credit the buyer can avail. The same needs to be specified.
- Cash Discount Terms: Discounts may be offered if the payment is made within a specified timeframe, which must be before the final day of the credit period.
- Default Terms: The agreement may specify the consequences that will occur if the debtor fails to make the payment within the allowed credit period. The default of payment may result in interest, penalty, or contract termination.
Factors Influencing Credit Terms
Parties agree usually depend on the following factors:
- Product Life: The credit period depends on the life of the product. Usually, a longer product cycle means a more extended credit period and vice versa.
- Buyer’s Creditworthiness: The seller evaluates the buyer’s ability to make the payments before granting any credit in case of a new customer. For an existing customer, the experience plays an important role.
- Sellers’ Position: A seller decides the facilities it agrees to provide in the credit terms. Its negotiating power regarding the terms depends on its market position.
- Level of Competition: The credit terms of the competitors also influence the credit terms offered by the seller. The seller tries to provide better credit terms to attract more customers.
Credit Term Table
The table of the seller will look as below:
| Sr. No. | Creditor Name | Credit Limit | Credit Period |
| 1 | |||
| 2 | |||
| 3 |
More columns can be added based on the seller’s policy.
Accounting
The accounting shall be as follows in the books of the seller:
- If the creditor decides to make an early payment and qualifies for a cash discount, they will record the granted discount amount as an expense.
- If the credit doesn’t make the payment and a penalty or other charges are levied, the same shall be booked as an income. However, the need for making a provision for bad debts shall also be analyzed.
Advantages
- Extending a credit facility to the buyer enhances the business and the seller’s growth.
- There is practical usage of the funds by the buyer, and he gets to enjoy the credit period.
- The system serves as an alternative to the cash system and can be advantageous for establishing a business tradeline.
Disadvantages
- There is a credit risk to the seller that the payments might not be received on time or at all.
- Sometimes, credit facility comes at additional costs, and buying the same product can be less costly when made in cash.
Tips
- The seller should ensure the buyer’s creditworthiness before extending any credit limit.
- The seller shall review whether the payments are being received on time or if there is a need to revise the credit limit.
- The buyer shall utilize the maximum credit limit to its advantage.
Conclusion
Credit limits decide the terms of payments between the seller and the buyer. The words are advancing with time, and businesses are finding new ways to provide the best to their customers. However, one must ensure the other party’s creditworthiness before extending any credit.
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This is a guide to Credit Terms. Here we also discuss the definition and types along with their advantages and disadvantages. You may also have a look at the following articles to learn more –
