How business credit works – Many businesses of any size can access business credit, which can help them financially.
It can provide better cash flow, buying power, and supplier relationships. And when used wisely, this can be a valuable asset to any business.
In this article, you will learn what this type of credit is and how it works, in addition to its advantages and costs.
What is trade credit?
Trade credit is a type of line of credit. It is a type of credit that suppliers grant to companies. It allows businesses to purchase goods or services before they have the cash to pay for them.
This credit can provide working capital to cover inventory costs, expansion, or other business needs. It is an essential tool for managing cash.
What is the importance of trade credit?
Trade credit is essential because it allows businesses to purchase the goods and services they need to function without having to pay for them upfront.
This can be useful for businesses that are just starting out and don’t have a lot of cash flow or for companies that need to build up stock before a peak season.
Lastly, it helps businesses build a good credit history. This can help companies to get financing in the future.
Advantages and Disadvantages of Trade Credit
Trade credit provides several benefits:
- You can help a business struggling with cash flow to get needed goods and services.
- Flexible payment terms when paying for goods or services. This can be useful for managing cash and preserving working capital.
- Greater purchasing power can help companies take advantage of early payment discounts, or special price offers from suppliers. This can save money and help improve profitability in the long run.
- Improving relationships with suppliers Establishing a good relationship with suppliers can lead to more favourable conditions, better prices and delivery times.
- Protection against risks, such as fluctuations in the prices of raw materials or unexpected changes in market demand.
Trade credit also has some disadvantages.
- Create a liability on the balance sheet. Accountants call it accounts payable.
- It can also create a lot of short-term debt if a company uses it frequently.
- Finally, it can make bookkeeping difficult.
How does business credit work?
Every transaction that happens under a trade credit is recorded on an invoice. Then the shipment is made. The buyer must sign the invoice for proof of receipt.
The buyer and the seller must record the transaction in their accounting records. You can also send a promissory note.
In most cases, the buyer has from one week to 6 months to pay the invoice issued under the credit. Some providers may offer terms longer than 6 months.
Typically, interest is not charged for this type of credit. However, a business may qualify for a discount if it pays the invoice quickly. If you don’t, you lose the deal.
Trade Credit Example
A home builder can purchase lumber from a supplier on 2/7 terms, net 30 days. The builder will receive a 2% discount if he pays the invoice in 7 days or less.
Regardless of the buyer’s decision, they must pay the full invoice within 30 days. If you pay after 7 days, you don’t get the discount.
- The first number in the terms is the amount of discount available.
- The second number shows how long the invoice must be paid to get the discount.
- And the final number shows the due date to pay the bill.
If the provider does not offer a discount, the terms will only say “net 2 months” if the invoice payment is due within 2 months.
open account credit
It is an agreement in which the seller allows the buyer to purchase goods or services and pay for them later. The most common example of open account credit is buying food at the supermarket.
Credit secured with a check.
It is a commercial credit in which the creditor has a check from the debtor as a guarantee for the loan, and it is also usually short-term. The interest rate of this credit is generally higher than that of other commercial loans because there is more risk for the lender.
Payment. However, these savings are usually much less than the discount for paying early.
Commercial credit as a company
As we have seen, business credit can significantly help a small business. But most providers won’t offer it to startups.
An alternative could be a small business loan, although most lenders require at least 2 years of business history.
Small businesses with an established track record can ask their vendors for trade credit. Most providers offer this service.
When you apply for this credit, do not forget to have your business plan ready and ask to speak with the owner or the person in charge of credit and financing.
Remember that obtaining a loan is not guaranteed. A seller needs to be sure that you will pay. So the longer you’ve been in business with that particular provider, the more opportunities you’ll have.
Before granting business credit, a seller typically checks:
- Credit reports. These may include business and personal accounts. Remember that good credit utilization will improve your credit scores.
- Financial documents. Vendors may want to see your company’s balance sheet, income, and cash flow statement.
- Payment history. If you have a good payment history with the provider, they may extend your credit.
Trade credit as a supplier
You can offer trade credit to increase sales if your company supplies other businesses.
If you decide to offer trade credit, remember that this is primarily an advantage for the buyer. A company might choose to pay earlier, which means you would lose some revenue. Or if they definitely don’t pay, you will have losses.
When you offer this option to an individual customer, don’t forget to do an assessment similar to the one we just discussed payment history, financial documents, and credit reports.
What is your financial solution?
Many small businesses rely on various financing options, including business credit cards, business credit, and small business loans.
At Camino Financial, we are specialized in small business loans. We offer competitive interest rates and flexible terms so you can get the financing you need without putting your business at risk.
Contact us today to learn more about our loans and how we can help your business grow.
