The B2B Trade Credit Guide

Learn more about this essential financing tool to help grow your business.

What Exactly Is Trade Credit?

Trade credit is a B2B agreement where a customer purchases some sort of product or service, but pays for it at a later time as agreed on by the two parties. This is traditionally a period of between 30 and 90 days later. Likewise, another way of putting it is that it is when a customer puts their order on a “tab.” This is a casual credit agreement between the buyer and a seller that allows the businesses to be able to order goods they need and not have to pay for them immediately.

But did you ever think that getting your business needs met immediately doesn’t have to be so complex? If your company normally makes big purchases through outside vendors to obtain things like office supplies or furniture, inventory to fill your stockroom or whatever raw materials your business needs to produce its products, then the top place to get the funds you need to buy those things could essentially be your vendors.

The truth is this type of funding agreement, which is known as trade credit, happens more than you may believe.

How Trade Credit Works

As stated earlier, trade credit lets customers order and get the things they need immediately and pay for them usually 30 days up to 90 days later. It’s a fantastic way for a small business owner to get stocked up even if they don’t have the cash to pay for the items at the time of their order.

For instance, imagine you just started a soap business where your company creates, manufactures, and then sells natural soap. However, in order to have the soap for sale in your store, you need a starting inventory of materials and equipment to make the soap. And the problem is you don’t have enough funds to get these things since you can’t sell products you haven’t created as yet to make any money.

Of course you might decide to invest some of your personal cash into your new business, or choose to get funding from a commercial lender, a friend, a relative or some kind of lender online. Or what if you found a supplier who was willing to provide you with the soap materials you need and would wait a month or two for payment? That would provide you time to produce your soap and sell them, thus making enough money to be able to both pay your supplier and have money left for your own needs.

This last possibility is a characteristic sample of trade credit.

The Cost of Trade Credit

The majority of trade credit contracts don’t charge you interest per say, however, you must pay strict attention to whatever the terms of that agreement is because that old saying that nothing in life is for free is quite true.

Here are the two top methods suppliers ensure they don’t lose out on their own investments when they get into a trade credit partnership. From a client’s perspective, this is the cost of agreeing to a trade credit deal, just like you would have expected to pay interest via a traditional loan.

Early Payment Discounts

Sometimes a vendor will agree to a deal of paying off the invoice in between 30 and 45 days and in that agreement there is a deal for providing you with some sort of discount if you pay cash at the point of delivery or pay off your bill early. For instance, they might give you a 2 percent discount if you paid it in cash or paid it off within 10 days of receipt.

That sounds wonderful, doesn’t it? What a great guy your vendor must be if they are both willing to provide your business with a trade credit, but even offering a discount like this. However, pay attention just a minute. Is it a real discount or not?

You have to consider that the vendor set their price for that invoice, so if they are willing to also give you a discount for paying it off early or paying it in cash, it’s likely they have already added that percentage to your order as part of the reason why they are willing to enter into the trade credit agreement.

That’s why you always have to remember that if you enter into a trade credit with a vendor, even though it may not seem so at first, the deal is still a type of debt. That means there is always going to be a cost. Remember, there is no free lunch!

Late Payment Penalties

Just like your vendor may give you a discount if you pay off the bill early, if you pay it late they likely will make you pay a penalty. This is because too many vendors have been burned in the past by unscrupulous customers, so they now include these terms in a trade credit deal.

Actually, your accountant will likely tell you that if the trade credit deal doesn’t in fact have a late fee penalty, there isn’t a true due date! Due to this, most vendors stick on between 10 and 15 percent as a late fee if you don’t pay by the agreed upon date, and many times this gets added on automatically, so don’t forget that due date!

And most of all, paying it late will give you a bad reputation with vendors and no one is going to one to help you in the future! And late payments may also ruin your credit report, which also jeopardizes your chances of getting a conventional loan as well.

So, if there is ever a time when you have an unforeseen problem and need to pay your vendor late, be sure to let them know as soon as possible and they are likely to be a bit more understanding than if you just let the date slide and never say a word.

And on the plus side, when you have a record of paying your vendors either early or on time, and the vendor reports your prompt payments to the credit bureaus, this will help you get a higher credit score and make it easier to get a conventional loan if you need it.

Extending Trade Credit to Customers

If you run a small B2B company, you could discover yourself acting as a customer and as a vendor. Just like a trade credit agreement helps your business when you are the customer, it can also help your own customers and they will likely pick your company over another one that wasn’t willing to give them trade credit.

Even so, it is risky extending trade credit to a buyer, since they could hurt your own cash flow if they pay you late, so prior to agreeing to a trade credit you should follow these recommendations:

Check Your Customer’s Credit Rating

Some B2B merchants don’t run a credit check on a new buyer prior to extending trade credit, but it’s prudent to do so, especially if the order is a large one. The majority of the time if that customer is going to pay you late, they have done it to another vendor and have a bad record. To save yourself from this scenario, you should run a free credit check on them at Shekal prior to agreeing to trade credit. This could save you thousands of dollars in the long term.

Setting Up Credit Terms

Just like previously explained when you as a customer had to agree to set terms prior to your vendor agreeing to extend a trade credit to your business, you need to do the same if you get into a trade credit agreement with one of your customers. Just follow the same guidelines as to listing payment dates, any late penalties, early discounts, etc., and ensure your client understands and agrees to your terms.

It’s not a bad idea to use some kind of accounting software to automate things like payment date reminders or notifications if they pay late. That way you won’t have to deal with having any angry discussions with a late paying customer.

Invoice Financing During Cash Flow Crises

Even if you do your best to plan ahead, you likely will have at least a few customers who pay late, which could put you in a cash flow crisis. If that happens you won’t be able to pay your own vendors and this is the type of domino effect that happens many times between a B2B vendor and a customer.

To avoid this kind of risk, you can consider using invoice financing as an possible option so you can pay for your own immediate needs. Using invoice financing you can get access to as much as 95 percent of the value of an invoice, and the rest of the monies remains in reserve until the customer has paid the money owed on the invoice.

This can be an expensive answer to your problem, but in the long run it’s better to find ways to keep from having a sudden cash flow problem.

What about Trade Credit Insurance?

If your business gets into a lot of trade credit arrangements, and many of your customers are high risk ones, your price for invoice financing will mount up fast. So instead, your risk manager may suggest that you buy trade credit insurance that will protect your income against any orders that go unpaid.

This kind of insurance is mostly offered to companies dealing in exporting goods internationally, because things like distance, political climate change, or complicated legal issues can cause more chances for your customers to not pay you. But if you mostly enter into trade credit deals with local customers that you have dealt with in the past, then likely you don’t need to spend money on trade credit insurance.

Common Questions

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