Trade Credit Definition
Trade credit is a business-to-business (B2B) agreement to buy goods and/or services but without paying for them on the spot when they are delivered. This way, businesses can sell their products before payment is due or use the freed-up cash flow for other things. The parameters of this credit are set by credit terms agreed to by the parties. This is traditionally a period of between 30 and 90 days later.
How Does Trade Credit Work?
Usually when the goods are delivered, the seller extends trade credit for specific number of days, e.g., 30, 60 or 90 days. Trade credit is a fantastic way for a small business owner to get stocked up on goods even if they don’t have the cash to pay for the items at the time of their order.
Trade credit terms can be hammered out on the phone and confirmed in writing later. This will depend on the business’s relationship with suppliers and history with them. Vendors or suppliers, however, do not typically extend trade credit to businesses that have yet to establish good credit or that have not proven that they are able to make payments on time. Hence, new businesses may have to rely on cash on delivery (COD) until they have more of a financial track record.
At times, a seller may give a cash discount if the business pays within a certain period of time. For example, the business gets a 2 percent discount if the supplier gets paid within 10 days of issuing a 30-day credit.