Credit Terms and Discount Period

Credit Terms

• Credit terms are a listing of the amounts and timing of payments between a buyer and a seller, and the discount percent if the payment is made within a certain time period.
• The equation for setting up the terms is: n/10 = EOM, where EOM means “end of month” and most invoices are due for payment in 30 days, thus making the EOM 30 days.
• The “n” in this case means the discount percent if the payment is made within 10 days.

Discount Period

• The discount period is the time period in which a cash discount is available and a reduced payment can be made by the buyer, taking advantage of a reduction in selling price.

FOB (Free on Board)

• FOB is an abbreviation for Free on Board and is used to describe credit terms for transactions of merchandise purchases on credit.
• The buyer and seller must reach an agreement on who is responsible for paying any freight costs and who bears the risk of loss during transit when the merchandise is being shipped.
• FOB shipping point: the buyer accepts ownership at the seller’s place of business, pays shipping costs, and bears ownership and risks of damage/loss when the goods are in transit or in transport.
• FOB destination: ownership of the goods transfers to the buyer when goods are delivered at the buyer’s place of business, with the seller paying shipping costs and bearing the risk of damage/loss while in transit/transport.

Purchase Discounts

• Merchandise bought on credit requires a clear statement of expected amounts and dates of future payments as well as terms of credit.
• A seller offering a cash discount when the credit period is long is encouraging the buyer to make prompt payment, which the buyer views as a purchase discount and the seller views as a sales discount.

Cash Discounts

• Companies giving cash discounts to their customers recognize these discounts as ‘Sales discounts’ on their books.
• Cash discounts are offered to increase customer walk-ins, increase sales during recessions or holiday sales, and to reduce the time needed to pay suppliers for merchandise.

Cost of Goods Sold

• Merchandise is referred to as goods that a company acquires for the purpose of reselling them to customers.
• The cost of this merchandise is called Cost of goods sold and is a direct expense item on the Income statement.

Learn about credit terms, including the equation for setting up terms, discount periods, and payment timing between buyers and sellers.