What is trade credit?
Trade credit is a short-term financing arrangement that allows customers to purchase goods and services from suppliers and pay for them at a later date. Trade credit is also known as vendor credit or net term. This type of loan is commonly used by business-to-business (B2B) companies. Trade credit is a great option for managing cash flow and building business credit.
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How does trade credit work?
Trade credit does not work like traditional small business financing. This type of loan is a more informal credit arrangement between a customer and a supplier rather than a formal contract between a lender and a borrower. In a trade credit agreement, a supplier agrees to provide goods or services and a customer agrees to pay for them at a later date.
Trade credits are typically provided for 7, 30, 60, 90, or 120 days. These payment terms are often referred to as “net + days.” For example, a Net 30 contract means you have 30 days to pay for your purchases.
Some suppliers may also offer discounts to encourage customers to pay early. For example, a vendor may offer a 3% discount if you pay within 7 days of a 30-day payment period. This arrangement is called 3/7, net 30.
Trade credit is considered a 0% interest loan, but the vendor may charge a fee if you do not pay by the agreed upon date. These late penalties, as well as product prices and payment terms, are specified in trade credit agreements and invoices.
You can build business credit by using it responsibly (i.e., paying on time). Some suppliers automatically report payment history to business credit bureaus. If not, you can list it as a trade reference on your credit account. Dun & Bradstreet (one of the commercial credit bureaus) will contact you to collect transaction data.
Trade credit example
Here is a detailed example of how trade credit works:
Connect with suppliers. You found a supplier who sells T-shirts for $2.50 each. You decide to buy 1,000 T-shirts.
Supplier provides trade credit. You agree to the supplier’s sales price and payment terms (2/10, net 30).
Your supplier will send you an invoice. The supplier sends an invoice with the agreed price and terms. The invoice will also detail the supplier’s late fee policy. Supplier will charge an additional $20 fee for each day past the deadline.
Pay your supplier for your T-shirt order. If you pay your supplier within 10 days, you will receive a 2% discount off the sale price of your T-shirt. You pay $2.45 per shirt (instead of $2.50) for a total cost of $2,450. If you pay on the 30th day, you will be charged the standard total amount of $2,500 for your order. Please note that late payments will incur a $20 late fee. For example, if your payment is 5 days late, you’ll pay an additional $100.
How to get trade credit
If you are interested in trade credit, you can ask your supplier or vendor about the options they offer. Note that even if a supplier offers trade credit, they may not be willing to extend it to your business.
Although trade credit may not have a formal underwriting process (as is often seen with traditional debt financing), suppliers will still evaluate your business to decide whether they want to extend credit to you. .
Suppliers may consider:
Credit history. Vendors may prioritize business credit scores over personal credit because the former incorporates payment history to creditors and vendors.
business finance. Your supplier may request to see your financial statements to confirm available cash flow and inventory turnover.
Payment history with them. If you’ve worked with a supplier before, the company will look at your history to assess the likelihood of late payments or no payments at all.
Payment history and relationships with other suppliers. These details can be found on your business credit report, but your supplier may also ask for references to contact you directly with suppliers you have worked with in the past.
Suppliers also use these factors to determine the specific payment terms they offer. Suppliers are more likely to agree to longer terms if you have a good payment history. The payment terms you receive will also vary depending on your industry, the size of your purchase, and the perishability of your items.
Once a supplier agrees to a trade credit agreement, all they need to do is send an invoice as a record of the agreement. However, some suppliers may require you to sign a promissory note.
A promissory note is similar to a legal “debt.” This type of documentation helps protect suppliers from non-payment. Without a promissory note, a supplier could end up with bad debts (i.e., debts that cannot be collected). Although bad debts can be written off with taxes, they can have a negative impact on a supplier’s finances.
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5.0
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EST (Eastern Standard Time. April)
20.00-50.00% depending on your creditworthiness and financial situation of your business
EST (Eastern Standard Time. April)
27.20-99.90% Based on loans originated in the half year ending March 31, 2024. The lowest interest rate offered is the interest rate received by at least 5% of our customers.
EST (Eastern Standard Time. April)
15.22-45.00% depending on your creditworthiness and financial situation of your business
Advantages and disadvantages of trade credit
The advantages and disadvantages of trade credit are different for suppliers and customers.
For customers
Strong Points
They are easier to qualify for than traditional business loans.
Affordable short-term financing.
You may receive a discount if you pay early.
Helps establish relationships with suppliers.
It can be used to build business credibility.
Cons
If you don’t pay on time, late fees can be high.
Late or missed payments can damage your business goodwill and supplier relationships.
For suppliers
Strong Points
It helps you build strong relationships with your customers.
Promote customer loyalty.
This can lead to increased sales volume.
Cons
Revenue from sales will be delayed.
Accounts receivable management becomes difficult.
You can end up in bad debt (if a customer doesn’t pay for an order).
Alternatives to trade credit
While trade credit is a good option for purchasing goods from vendors, it is not a viable option for long-term financing or other business needs. Here are some alternatives to consider depending on your different funding objectives.
For large business investments. If you want to make a bigger investment in your business, such as expanding or renovating your location, you may want to consider a long-term business loan. These loans offer large amounts of financing and repayment terms of up to 10 years.
For the purchase of equipment. If you need to purchase or upgrade equipment, consider dedicated equipment financing. Because these loans are secured by purchased equipment, they are easier to qualify for than traditional business loans.
Addresses general working capital needs. If you want a flexible financial product that can be used for a variety of purposes, consider a business line of credit. A line of credit works like a credit card. That is, you withdraw from a set of funds and pay interest only on what you use. Once you have paid back the money you borrowed, you can continue drawing the line.
FAQ
How much does a trade credit cost?
There is no cost to transact credit if you pay the supplier within the specified period. However, if payment is late, the supplier may charge a penalty fee.
What are the most common conditions for using trade credit?
The most common terms for trade credit are 7, 30, 60, 90, or 120 days. However, terms may vary depending on supplier, industry, and other factors.
Trade credit is provided by suppliers (vendors) and utilized by customers (buyers). Trade credit is a common arrangement between business-to-business companies, especially those in the wholesale and manufacturing industries.
