Definition: A credit period is the time frame between when a customer purchases a product and when the customer’s payment is due. In other words, this is the amount of time a customer has to pay for the product.
What Does Credit Period 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 the products.
Before a credit sale can be made, credit terms must be established. 2/10 N/30 is the standard term for transactions across almost all industries. This means that if the customer pays for the product within ten days he gets a 2 percent cash discount. If the discount isn’t taken, the customer must pay the full invoice price within 30 days from the purchase. This 30-day time frame is considered the credit period. It’s the amount of time the seller is giving the buyer credit for the transaction.
Let’s take a look at an example.
Tim’s Machine Shop purchases steel and other raw materials from vendors on a regular basis. As part of his agreement with these vendors, he can pay cash for these purchases within 5 days and receive a 15 percent discount. Otherwise, all payments are due within 25 days.
The first five-day period is considered the early pay discount period. Tim can pay for the entire order in the five-day window if he wants to, but he isn’t required to. Tim is however required to pay for the full order within 25 days. This means the vendor is giving Tim a credit period of 25 days to pay for the purchase.
Businesses like Tim’s can use the extra 25 days to structure their cash flows appropriately. Since the full payments aren’t due up front, Tim can order the materials he needs, sell them to a customer, and pay the vendor with the income received from the customer.