How to make the most of an installment payment
With installment payments, large invoice amounts can be divided into smaller partial amounts that are paid over a certain period of time. This can be advantageous for both customers and companies. We show you here what types of installment payments there are, how to calculate them, if interest is included, and when it is worth offering this payment method.
With an installment payment, a customer pays off his invoice in several small instalments over a certain period of time. This payment method is often chosen when a large invoice amount has to be paid. But it is up to the seller when and if he wants to offer installment payments.
The conditions are defined in the payment terms. In most cases, the invoice amount is divided into equal instalments that are paid over a fixed period of time (e.g. 3 months).
Installment payments are used in the following situations:
- Customer payment to seller: The payment method is contractually agreed between customer and seller
- Loan repayment: The borrower repays a loan plus interest to the bank in installments
- Debt repayment: The debtor pays the amount owed back to the creditor without interest (e.g. in the case of tax debts).
How the installment payment agreement is structured is left to the seller. The seller can specify in the payment terms how the individual installations are to be paid for.
An online merchant specifies in his payment terms that goods can be paid for in installments from an amount of £500. When issuing an invoice to a customer, it makes sense to break down the instalments to be paid and by when they have to be paid. This can look like this:
Total amount due: £600 Payable in 3 monthly installments of £200 each on the 1st of each month.
This way, it is clear by when the due instalment must be paid, so that no misunderstandings arise.
In the case of installment payments that include interest, it should also be pointed out how the individual installments are made up in order to avoid misunderstandings. The following formulas can be used for this purpose:
Total amount due = Net amount + (Net amount / 100 x Interest rate)
Monthly installments = Total amount due / Number of months Example: Installment payment for a loan
We illustrate the above formula with a common example from practice: A borrower wants to take out a bank loan of £100,000. The bank agrees with him an interest rate of 5% and a credit period of 6 years. Now we want to know what the monthly instalments are. To do this, we insert the values into the formulas above:
Total amount due = £100,000 + (£100,000 / 100 x 5) = £105,000 Monthly installments = £105,000 / (6 x 12) = £1,458.33
So the monthly instalments are £1,458.33 for the next 6 years.
Some companies wonder whether it is generally a good idea to offer customers an installment payment plan. Installment payments can be an advantage for companies because they can help their customers by not having to pay the entire invoice amount at once.
Especially in the case of high invoice amounts, offering installment payments can make customers more likely to buy, which ultimately increases the company's revenue.
In addition, with installment payments, companies receive a smaller amount of money on an ongoing basis instead of a large sum after a longer period of time. In this way, the cash flow can be planned and regulated very well in advance.
In some cases, however, an installment payment agreement can also be disadvantageous. If a company does not have sufficient cash reserves, installment payments can lead to a cash shortage because the cash inflow is not high enough to compensate for the cash outflow. In this case, it is better to let customers pay in advance so that the money is available in full right away.
If you mainly sell goods that have low prices, it is not worth offering installment payments - especially if many customers make use of them. The cash inflow is then low and can also lead to a cash shortage.