Lesson 65 - Beginner accounting course

65. Credit Terms and Their Impact on Business Cash Flow

Offering credit to customers can increase sales, but it also affects cash flow and financial stability. Businesses must carefully structure their credit terms to balance sales growth and timely cash collection.

1. What Are Credit Terms?

Credit terms define the conditions under which a business allows customers to make purchases on credit and defer payment. These terms outline:

✔ Payment Due Dates (e.g., within 30 days)
✔ Discounts for Early Payment (e.g., 2% off if paid within 10 days)
✔ Late Payment Penalties (e.g., interest charges on overdue amounts)

2. Common Credit Terms and Their Meaning 

3. How Credit Terms Affect Business Cash Flow

A. Positive Effects of Offering Credit
✔ Increases Sales – Customers are more likely to buy if they don’t have to pay immediately.
✔ Builds Customer Loyalty – Flexible credit terms can strengthen business relationships.
✔ Gives a Competitive Advantage – Businesses that offer better credit terms attract more clients.

B. Negative Effects on Cash Flow
✖ Delays Cash Inflow – The longer the credit period, the longer the business waits for payment.
✖ Risk of Bad Debts – Some customers may never pay, leading to financial losses.
✖ Increases Borrowing Needs – If cash is tied up in receivables, businesses may need loans to cover expenses.

4. Managing Credit Terms to Protect Cash Flow

A. Setting the Right Credit Terms

• Offer shorter payment terms (e.g., Net 15 or Net 30) to improve cash flow.

• Provide early payment discounts to encourage quicker payments.

• Require deposits or partial payments upfront for large orders.

B. Evaluating Customer Creditworthiness

Before offering credit, businesses should assess a customer’s ability to pay:
✔ Check credit history and past payment behavior.
✔ Set credit limits to reduce risk.
✔ Monitor aging reports to track overdue payments.

C. Enforcing Payment Policies

• Send reminders before due dates to reduce late payments.

• Charge interest on overdue invoices to discourage delays.

• Offer automated payment options for faster collection.

5. Example: The Impact of Credit Terms on Cash Flow

Scenario 1: No Credit (Cash Sales Only)

• A company sells €10,000 worth of goods every month.

• Customers pay immediately, so the business has €10,000 in cash flow per month.

Scenario 2: Net 30 Credit Terms

• The company still sells €10,000 per month, but customers pay after 30 days.

• In the first month, cash flow is €0 because no payments have been collected yet.

• After 30 days, the company receives the first €10,000, but sales continue.

• Cash flow is delayed, increasing the risk of liquidity problems.

Scenario 3: 2/10, Net 30 Terms

• The company offers a 2% discount if customers pay within 10 days.

• If most customers pay early, the company gets cash faster, even with a slight revenue reduction.

• Cash flow improves because funds are available sooner for business expenses.

6. Key Takeaways

✔ Credit terms impact cash flow, profitability, and business stability.
✔ Shorter payment terms and early payment incentives help improve cash flow.
✔ Evaluating customer creditworthiness reduces the risk of non-payment.
✔ Monitoring accounts receivable ensures timely collections.

By setting smart credit policies, businesses can increase sales while maintaining strong cash flow, reducing the risk of financial strain.