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Deciding on Payment Terms for Accounts Payable

written by: •edited by: Michele McDonough•updated: 1/4/2011

Your business is up and running and you’ve just realized you need to apply for some credit accounts from your suppliers. Or, you’ve just been asked by a customer if they can set up a credit account. What are the rules for accounts payable terms? Jean Scheid explores A/P.

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    Applying for Credit

    Setting Credit Terms Is Important If you’re applying for credit and need credit accounts to purchase supplies and inventory, you will most likely be asked to fill out a credit application. Be prepared to include the legal name of your business, Federal Tax Identification number, sales tax number, bank references, and names of owners as well as their social security numbers. If you have established credit accounts, you may be asked to provide a contact name and telephone number for those as well.

    In order for a new vendor or supplier to set accounts payable payment terms, most likely they’ll review your application, contact bank or credit references and then determine a limit on how much you can charge each month. They will also set due dates for submitting timely payments. These are usually net 10, 15 or 30, meaning once they send out their invoice, you have ten, fifteen or thirty days to pay in full.

    In these days of no-liability corporate entities, be prepared to sign personal guarantees for credit accounts; often this is the only way a vendor or supplier can guarantee they’ll get paid.

    Image Credit (freedigitalphotos)

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    Granting Credit

    If you’re a new business owner, you will be asked to grant credit to some of your customers and that means offering up a business credit application for them to complete. First, you can find a free template of a business credit application in our Media Gallery if you don’t already have one created. You can use this template and modify it to fit your needs.

    Once the application is complete, be sure to check references and ask about other accounts payable payment terms and if the credit applicant has been on time with payments and pays in full each month. Do be sure to check even the applicant's bank record and see if they have a history of returned checks. By signing the credit application, they are giving you the right to explore their background.

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    Setting the Terms

    Pay and Be Paid on Time To determine how to set terms or accept the terms of a creditor, all businesses need to take a look at their own cash flow.

    If you are a business applying for credit, when do you see the most cash flow coming in? If it’s near the beginning of the month, you may want to request net 10 days terms, meaning you will pay your creditor’s account in 10 days. If you find your money is near the middle or end of the month, you may want to request net 15 or net 30.

    If the only option a creditor gives you doesn’t mesh well with your cash flow, ask if you can have different accounts payable payment terms that do fit within your cash flow.

    If you are granting credit to a customer, you also have bills to pay. For new businesses, it’s best to put them on a net 10 payment plan and don’t set their credit limit too high. Once you see they pay on time, you can always change the A/P payment terms and raise the credit limit.

    You should also look at when most of your bills are due as well. If you need much cash at the beginning of the month, you’ll want to make sure your customers pay on time; often net 30 may be asking too much and net 15 is your best choice. Plan for late payments and do charge late fees and interest penalties, even if they’re only small amounts. This will make your customers make the effort to pay on time and in full.

    Once you see payments coming in, think of what you have due as far as payables and operating expenses. Try not to use all your accounts payables coming in to pay your rent and payroll expenses. Use your accounts receivables to pay off your accounts payables—this is a best practice in receivables and payables.

    Image Credit (freedigitalphotos)

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    Be Flexible

    Whether you’re granting credit or applying for credit, try and be flexible on accounts payable payment terms. Because you will be both a creditor and a customer, you can benefit the most if you are flexible but still strive to ensure you pay on time and are paid on time.