Granting payment terms has a cost.
This cost is not always obvious, because it does not appear as a separate invoice. It does not look like a visible discount on a quote. It does not necessarily show up in the commercial margin. Yet it exists.
When a customer pays in 60 or 90 days, the company ties up cash in a receivable. It finances that delay, bears the risk of late payment, spends time on follow-up, and accepts the possibility that payment may arrive partially, late or not at all.
Calculating the cost of customer credit is about making this reality visible.
The objective is not to build a complex financial model. The objective is to provide a simple method to answer very concrete questions:
Is a customer paying in 90 days truly profitable?
Should a long payment term be built into the price?
Should this payment condition be accepted?
Should a down payment be requested?
Should the credit limit be reduced?
Should this customer be treated differently from another customer that pays faster?
To answer properly, several elements must be considered: the receivable amount, the period during which capital is tied up, the financing cost, the probability of delay, the management cost and the risk of non-payment.
The Starting Point: The Amount Financed
The first element to identify is the amount the company is financing.
In a sale on credit, this amount generally corresponds to the invoice or to the customer exposure.
If a company sells 100,000 euros with payment in 60 days, it finances 100,000 euros for 60 days, as a first approximation.
But in reality, it is sometimes necessary to think more broadly.
A customer may have several open invoices at the same time. It may place orders every month. It may have invoices not yet due, overdue invoices, disputes, pending credit notes or partial payments.
In that case, the right amount to look at is not only the latest invoice. It is the customer’s total outstanding balance.
Customer exposure represents everything the customer still owes the company at a given point in time.
The higher this exposure, the more capital is tied up.
A payment term on a small invoice may be insignificant. The same term for a customer representing several hundred thousand euros of exposure can become a major issue.
The first question is therefore simple: how much money is the company willing to leave temporarily with this customer?
Duration: How Long the Cash Remains Tied Up
The second element is the duration of the tie-up.
A customer that pays in 30 days does not consume as much capital as a customer that pays in 90 days. For the same amount, the second ties up cash three times longer.
Two durations must be distinguished.
The contractual duration is the one stated in the payment terms: 30 days, 45 days, 60 days, 90 days.
The actual duration is the one observed in the customer’s payments.
The actual duration is often more important for analysis.
A customer may have 60-day terms but usually pay in 75 days. In that case, the real economic cost must be calculated over 75 days, not only 60.
Conversely, a customer may have long terms but respect due dates perfectly. It consumes capital, but predictably.
The cost of customer credit therefore depends on the real time during which cash remains tied up in the receivable.
The longer this duration, the higher the cost.
Financing Cost: How Much the Tied-Up Money Costs
The third element is the financing cost.
If the company must borrow or use a short-term facility to finance customer receivables, this cost can be quite visible. It may correspond to a bank rate, the cost of an overdraft, the cost of treasury financing or the cost of factoring.
Even if the company does not borrow, there is still an economic cost: the tied-up cash could have been used elsewhere. It could have reduced debt, financed an investment, avoided an overdraft, paid a supplier earlier or strengthened cash security.
For simplicity, the company can use an annual cost of capital or financing cost rate.
This rate does not need to be perfect to be useful. Above all, it should make situations comparable.
A company may, for example, use 5%, 8% or 10%, depending on its real financing cost, cash position or internal return requirement.
The important point is to understand the logic: if the company ties up 100,000 euros for part of the year, it bears a cost proportional to the amount, the time and the rate selected.
The Simple Formula for Financial Cost
The basic formula is:
Financial cost of customer credit = receivable amount × annual financing rate × duration of tie-up / 365 Take an example.
A company sells 100,000 euros to a customer.
The customer pays in 90 days.
The annual financing cost used by the company is 6%.
The calculation is:
100,000 × 6% × 90 / 365 = approximately 1,479 euros This means that the 90-day payment term costs approximately 1,479 euros in theoretical financial cost.
If the same customer paid in 30 days, the calculation would be:
100,000 × 6% × 30 / 365 = approximately 493 euros The difference between 90 days and 30 days is therefore approximately 986 euros.
This amount represents the additional financial cost linked to the extra 60 days of payment term.
This is not yet the total cost of the customer. It is only the financial cost of time.
But it already shows that the payment term is not neutral.
Reading the Cost as a Percentage of Margin
The calculation becomes more meaningful when compared with margin.
Let us keep the example of a 100,000-euro sale.
The gross margin is 15,000 euros.
The customer pays in 90 days.
The financial cost of the payment term, with an annual rate of 6%, is approximately 1,479 euros.
This cost represents almost 10% of the gross margin.
The apparent margin was 15,000 euros. After the financial cost of the delay, it falls economically to around 13,521 euros, before even considering management costs, possible delays, disputes or non-payment risk.
If the margin were only 5,000 euros, the same financial cost would represent nearly 30% of the margin.
This is where the analysis becomes useful.
A long payment term may be acceptable on a high-margin sale. It can become very heavy on a low-margin sale.
So the question is not only: “How much does the payment term cost?”
It is also: “What share of the margin does this payment term consume?”
Late Payment: The Real Cost Can Exceed the Expected Cost
The cost calculated from the contractual term is only a first estimate.
If the customer pays late, the cost increases.
A customer that was supposed to pay in 60 days but pays in 100 days consumes 40 additional days of financing.
On an invoice of 100,000 euros, with a financing cost of 6%, those 40 additional days cost approximately:
100,000 × 6% × 40 / 365 = approximately 658 euros This delay may seem limited on an isolated invoice. But multiplied across dozens or hundreds of invoices, it becomes significant.
Late payment also has another effect: it reduces cash predictability.
A company can organize financing if it knows that a customer always pays in 60 days. It is more exposed if the customer sometimes pays in 60, sometimes in 90, sometimes in 120.
Payment variability therefore also has economic value. It forces the company to keep more safety, mobilize more financing or strengthen follow-up.
The contractual term provides a basis. Actual behavior provides the economic truth.
Management Cost: Chasing, Monitoring, Resolving
The cost of customer credit is not limited to financial cost.
Management cost must also be included.
An invoice on credit must be monitored. The company must check that it has been issued, its due date, whether the customer has received it, its approval status, and then its payment. If everything goes well, this cost remains low.
But if the customer pays late, disputes, requests documents or pays partially, management cost increases.
Teams must follow up, search for information, communicate with the customer, contact the salesperson, check the order, provide proof of delivery, handle a dispute, issue a credit note, monitor a promise to pay or allocate a poorly referenced payment.
This management time has a real cost.
It is rarely allocated to a specific sale, but it consumes internal resources. It mobilizes Accounts Receivable, Collections, Customer Service, Sales, Operations and sometimes Legal.
For a simple method, the company can estimate an average management cost per invoice or per customer.
For example:
A simple invoice, paid on due date, costs little to manage.
An invoice chased three times and partially disputed costs much more.
A customer that regularly generates disputes consumes more resources than a smooth customer.
Even without a perfect calculation, this logic helps compare customers.
A customer that is profitable on paper may become less profitable if it requires a lot of effort to collect.
The Cost of Non-Payment Risk
The final important element is non-payment risk.
Granting credit means accepting that the customer may not pay, or may not pay in full.
This risk may be low for an established, solvent, regular and well-monitored customer. It may be higher for a new, fragile, opaque or late-paying customer, or one located in an unstable economic environment.
To integrate this risk simply, we can think in terms of expected loss.
The simplified formula is:
Expected loss = amount exposed × probability of default × loss given default Take an example.
A company has 100,000 euros of exposure to a customer.
It estimates the probability of non-payment at 2%.
It estimates that in the event of default, it would lose 60% of the amount, after possible recoveries.
The expected loss is:
100,000 × 2% × 60% = 1,200 euros This does not mean the company will lose exactly 1,200 euros. It means that the average economic risk, based on these assumptions, can be estimated at 1,200 euros.
This reasoning is useful for comparing two customers.
A very reliable customer with low risk may justify a longer term than a fragile customer with high risk.
Risk must be rewarded by margin, secured through conditions or limited by reasonable exposure.
A Simple Five-Step Method
To estimate the cost of credit granted to a customer, a company can follow a five-step method.
First step: determine the amount exposed.
This may be an invoice, an order or the customer’s total outstanding balance.
Second step: measure the actual tie-up period.
The company should look at the contractual term, but also the average term actually observed.
Third step: apply a financing cost.
Use a simple annual rate, such as the bank cost, the cost of capital or an internal rate selected by the company.
Fourth step: add management costs.
Estimate the time spent on monitoring, follow-up, dispute handling and account administration.
Fifth step: include non-payment risk.
Evaluate, even approximately, the probability of loss and its potential impact.
This method does not give a perfect truth. It gives an order of magnitude. And in commercial decision-making, an order of magnitude is better than intuition.
Full Example: Customer at 90 Days
Take a customer that wants to buy 100,000 euros with payment in 90 days.
The gross margin on the sale is 20,000 euros.
The company uses an annual financing cost of 6%.
The customer usually pays 15 days late.
The estimated actual duration is therefore 105 days.
The financial cost is:
100,000 × 6% × 105 / 365 = approximately 1,726 euros The company also estimates that this customer requires special follow-up: reminders, checks, additional documents. It estimates this management cost at 500 euros.
Finally, expected loss risk is estimated at 1% of the amount, or 1,000 euros.
The estimated total economic cost of customer credit is therefore:
1,726 + 500 + 1,000 = 3,226 euros The initial gross margin was 20,000 euros.
After taking the cost of customer credit into account, the adjusted economic margin becomes:
20,000 - 3,226 = 16,774 euros The sale is probably still attractive. But it does not have the same quality as if it were paid in 30 days, without delay and without specific management cost.
This method makes visible what revenue does not show.
Comparison: Customer A and Customer B
Now imagine two customers, each buying 100,000 euros with a gross margin of 20,000 euros.
Customer A pays in 30 days, without delay and with few disputes.
Customer B pays in 90 days, often with 20 days of delay, and requires significant follow-up.
For Customer A, with a financing cost of 6%, the financial cost is:
100,000 × 6% × 30 / 365 = approximately 493 euros Estimated management cost: 100 euros.
Estimated loss risk: 300 euros.
Estimated total cost: 893 euros.
Adjusted margin: 19,107 euros.
For Customer B, estimated actual duration: 110 days.
Financial cost:
100,000 × 6% × 110 / 365 = approximately 1,808 euros Estimated management cost: 700 euros.
Estimated loss risk: 1,500 euros.
Estimated total cost: 4,008 euros.
Adjusted margin: 15,992 euros.
Both customers generate the same revenue. The initial gross margin is identical. Yet the adjusted economic margin is very different.
Customer B is not necessarily a bad customer. But it consumes more capital, time and risk. It should therefore be managed differently.
Should the Payment Term Be Built into the Price?
When the cost of customer credit becomes significant, the company must ask whether the price should reflect it.
A customer asking for a long payment term receives a financial advantage. If it pays later, it keeps its cash for longer. The supplier, in turn, finances that delay.
It is therefore logical to ask whether the proposed price should be the same for upfront payment and for payment in 90 days.
In some markets, it will be difficult to explicitly increase the price. Competition may impose certain practices. The customer may refuse. The balance of power may be unfavorable.
But even if the company cannot always charge directly for the payment term, it must at least know what it costs.
It can then decide in several ways:
Maintain the price if the margin is sufficient.
Offer an early-payment discount.
Request a down payment to reduce the amount financed.
Shorten the payment term granted.
Set a strict credit limit.
Request a guarantee.
Increase the price to include financing.
Refuse the condition if adjusted profitability becomes insufficient.
The calculation does not automatically make the decision. It provides a basis for deciding.
Early-Payment Discount as a Comparison Tool
An early-payment discount is a reduction granted to the customer if it pays earlier.
For example: payment in 10 days with a 2% discount, instead of payment in 60 days without discount.
The discount makes it possible to compare the value of immediate cash with the value of the payment term.
If the company grants 2% to be paid 50 days earlier, it must ask whether the cost of that discount is lower or higher than the financing cost, the risk and the cash need.
In some cases, the discount can be attractive. It reduces customer WCR, accelerates cash, lowers risk and simplifies follow-up.
In other cases, it costs too much compared with the cash benefit.
The early-payment discount shows an important idea: time and price are linked.
Receiving money earlier has value. Receiving money later has a cost.
The Limits of the Calculation
Pragmatism is necessary.
Calculating the cost of customer credit often relies on assumptions: financing cost, actual payment delay, probability of default, management cost. These assumptions will never be perfectly exact.
But the objective is not absolute precision. The objective is to avoid blindness.
A simple estimate already supports better decisions than an unquantified commercial intuition.
It makes it possible to compare two customers, two payment terms, two payment conditions or two negotiation scenarios.
It also helps educate Sales teams: a payment term is an economic concession, not a simple administrative facility.
The calculation must therefore remain usable. If it becomes too complex, it will not be used in real decisions.
The right method is the one teams can understand and apply.
The Cost of Credit Should Inform Arbitration, Not Replace Judgment
Calculating the cost of credit does not mean deciding automatically.
A sale with a high credit cost may remain attractive if it opens a strategic market, strengthens a key customer or generates sufficient margin.
A sale with a low cost may be refused if the customer is doubtful, if documentation is poor or if legal risk is too high.
The calculation provides a rational basis. Judgment remains necessary.
This is the logic established in the first part of the book: customer credit must be economically justified, understood, limited, rewarded and managed. Credit Management is not there to eliminate all risks, but to help the company choose the right risks and avoid passive financing.
The calculation of the cost of credit is therefore an arbitration tool.
It allows the company to move from a vague discussion, “this customer pays a little late,” to an economic discussion, “this customer consumes around 4,000 euros of value on this sale, considering the payment term, delay, follow-up and risk.”
This precision changes the quality of the decision.
Practical Application: Questions to Ask Before Accepting 90 Days
When a customer asks for payment in 90 days, the company can use a series of simple questions.
What amount will be exposed?
How long will the cash actually remain tied up?
Does this customer respect due dates?
What is our financing cost?
What margin does the sale generate?
What share of that margin will be consumed by the payment term?
Does the customer generate disputes or specific management costs?
What is the risk of non-payment?
Is the requested term consistent with the market?
Can we obtain compensation: price, volume, guarantee, down payment, limit or commitment?
These questions turn a commercial request into an economic analysis.
They do not slow down the sale. They prevent the company from selling under conditions that destroy value.
Key Takeaways
Calculating the cost of credit granted to a customer means making visible the cost of time, tied-up capital, follow-up and risk.
The method can remain simple.
The company must identify the amount exposed, measure the actual duration of the tie-up, apply a financing cost, add management costs and include non-payment risk.
The basic formula for financial cost is:
Financial cost = receivable amount × annual financing rate × duration / 365 This calculation makes it possible to compare situations. A customer at 90 days does not cost the same as a customer at 30 days. A customer that pays late does not cost the same as a customer that respects due dates. A high-margin sale does not absorb the payment term in the same way as a low-margin sale.
The objective is not to turn every commercial decision into a complex mathematical exercise. The objective is to stop treating payment terms as a free concession.
A customer at 90 days can be profitable. But that must be demonstrated.
If the margin, volume, potential, risk quality and probability of collection compensate for the cost of credit, the decision may be justified. If not, the conditions must be adjusted: price, down payment, term, guarantee, credit limit or delivery method.
Customer credit becomes healthy when it is no longer hidden.
It becomes manageable when it is measured.