Definition: Credit terms or terms of credit is the agreement between a seller and buyer that lists the timing and amount of payments the buyer will make in the future. In other words, this is the contract that describes the specific details of the seller’s payment requirements that the buyer must meet into order to purchase goods on account.
What Does Credit Terms Mean?
Most companies have credit policies set up with vendors or customers, so purchases can be made on account. These credit purchases help speed up commerce and increase sales because it allows customers to purchase items before they actually have the funds to buy them.
Example
Before a credit sale can be made, credit terms must be established. Most terms are dictated by industry practices and the specific goods sold in those industries. A standard term rate that applies across most industries is 2/10 N/30—often called 2/10 net/30.
This is the standard way to write out and abbreviate term details. Here is a cypher to understand the code:
Percent discount if paid in cash / days to cash discount is available
Net amount of payment due / number of total days in credit period
These terms mean that a customer can receive a 2 percent discount on his purchase if he pays the entire balance in cash within 10 days. This is often referred to as the cash discount period. If the discount isn’t taken, the customer must pay the full invoice amount within 30 days of the purchase. This 30-day credit period is a sort of short-term financing for the customer. They can purchase goods without actually coming up with the cash immediately. They can then sell the goods to retail customers and pay for the goods within 30 days. This way the credit purchaser is never out of any cash.
Obviously, this is an ideal scenario that rarely happens, but this is the idea behind the terms.
