Contract payment terms are among the most important elements of a contract, and the stakes are high for businesses that get them wrong.
In this guide, you'll find out how to get your contract payment terms right first time, allowing you to avoid the friction and costs caused by errors and ambiguity.
What are contract payment terms?
Contract payment terms refer to the specific terms and conditions under which parties pay and get paid. These terms outline how and when payment will be made for goods delivered, services rendered, or work performed.
Why are contract payment terms important?
Contract payment terms are important because they give parties visibility into when money is expected to come into, or leave, their business. This is important for stabilizing cash flow and sticking to budgets.
They also form part of the contractual obligations between the parties, as a product or service is often provided in exchange for a fee. Failing to specify contract payment terms can result in disputes between parties and ambiguity, so it's important to outline them clearly.
Common contract payment terms
1. Sum of payment
The contract payment terms must stipulate the agreed-upon amount of compensation for the goods, services, or work provided. This can take various forms such as a lump sum, hourly rate, retainer fee, or installment payments.
The best way to calculate how much a counterparty will pay varies depending on the nature of the contract.
For example, procurement contracts can be fixed-price contracts, or they can be cost-reimbursement contracts, which means a contractor is paid a set fee for their work but is also reimbursed for any additional materials or costs incurred.
2. Payment method
Contract payment terms should always specify the preferred payment methods. These typically include wire transfers, checks, or electronic funds transfer (EFT).
However, each method will come with its pros and cons. Businesses usually opt for the payment method with the lowest fees and the fastest transfer rates. Failing to specify how counterparties should pay can jeopardize both of those things.
If the contract involves international transactions the chosen currency for payment must also be stated in the contract.
3. Payment schedule
All contracts should have a payment schedule that outlines when payments are due. It can be based on specific dates, project milestones, or other predetermined events.
For instance, a contract might stipulate that 30% of the total amount is due upon signing the contract, with additional payments due at certain project milestones.
This provides clarity when it comes to making and collecting payments, ensuring that all parties know when to expect payments to be made. It also protects parties in the event of non-payment since the schedule was outlined clearly in the contract itself.
Payment schedules can differ wildly between different businesses and projects. However, we’ve listed a few of the most common ones spotted in contract payment terms below.
Payment schedule examples
- Lump sum payment: a single, fixed amount paid in full upon completion of the contracted work or delivery of goods or services.
- Payment in installments: payments are made in multiple, predetermined installments at specific intervals or project milestones.
- Net payment terms: the total invoice amount is due within a specified number of days (e.g., "Net 30" means payment is due within 30 days of the invoice date).
- Progress payments: payments made at various stages or milestones of a project or service, often with a percentage of completion as a basis.
- Payment upon delivery: payment is made upon successful delivery of goods or completion of services.
- Advance payment: a portion of the total payment is made in advance before the work begins, often to cover initial expenses or costs.
- Recurring payments: regular, scheduled payments made at specific intervals, such as monthly or quarterly, for ongoing services or subscriptions.
4. Details on invoices and billing
Contract payment terms often include details on how invoices should be submitted, the payment due date, and any late payment penalties or interest charges. It's also important to include provisions for confirming the receipt of payments, such as receipts, acknowledgment of invoices, or other forms of documentation.
Again, what this section includes will vary depending on the nature of the contract and its objectives.
The problems with contract payment terms (and how to solve them)
1. Too much ambiguity
One of the most prevalent issues in contract payment terms is ambiguity. Ambiguous language or vague descriptions can lead to misunderstandings between parties.
For example, a payment term stating "payment due upon completion" could mean different things to different people. Is it upon the completion of a specific task, the entire project, or the delivery of goods?
To avoid ambiguity, payment terms should be specific, clearly outlining when, how much, and to whom payments are due.
2. Unjust late payment penalties
While it's important to have terms that encourage timely payments, setting excessively high late payment penalties can lead to dissatisfaction and disputes.
Contracts should strike a balance between protecting the interests of the payee and being fair to the payer. Overly punitive terms can strain business relationships and may even result in legal challenges.
3. Confusing when using change orders
Change orders, which modify the original contract, can significantly impact payment terms. Failing to address how changes in scope, timeline, or other project details will affect payment terms can lead to disagreements in the future.
To futureproof your contract payment terms, make sure your original contract includes provisions for handling change orders, including how they impact payment schedules and amounts.
4. Contract value leakage
Contract value leakage is a significant concern for businesses, often occurring due to loopholes and ambiguities in payment terms.
It refers to the loss of value or potential revenue from a contract because of unclear, poorly structured, or inadequately enforced payment terms.
Businesses can minimize contract value leakage by regaining control over contract payment terms. They can:
- Define clear and measurable milestones and deliverables, with payment terms explicitly outlining when payments are due based on these deliverables
- Clearly define invoicing procedures, clarifying the format, content and frequency within the contract payment terms
- Regularly audit and monitor contracts to ensure compliance and visibility into the contract metrics that matter, like contract payment terms
Regain control of your contract payment terms with Juro
When it comes to contract payment terms, most problems can be solved by focusing on two things:
- Drafting clear, specific and comprehensive contract payment terms
- Having visibility into payment terms and tracking compliance with them
By delivering in these areas, you can not only ensure that your contract payment terms are favourable and robust, but you can also monitor compliance with these terms once the contract has been executed properly, reducing cash flow problems.
Juro's intelligent contract automation software enables businesses to do both of these things, with automated contract templates that give legal and finance teams more control over contract payment terms, and a data-rich contract repository that makes tracking terms simple.
To find out more, fill in the form below to book your personalized demo.