Trade Credit

The success of your business can rest on getting the finance you need to buy materials, stock or equipment. Trade credit is one way you can make this happen – and it can be an extremely effective solution. It’s not unlike a ‘buy now, pay later’ promise that consumers can be offered when buying a big-ticket item. The idea of trade credit is built on the concept that you can buy what you need for your business without having to pay anything upfront.

It’s little wonder, therefore, that it’s a popular form of business finance. One report shows that 60% of the total value of business-to-business (B2B) sales in the UK are secured through trade credit. But this isn’t a guarantee that it’s the right option for each business. Understanding how it works – and all the potential pitfalls – will help you find out if this form of finance can help you.

So, here are many of the key points to consider as you decide which is the right path for your business.

What is trade credit?

The good news is that the definition of trade credit is a straightforward one. It’s an agreement between two businesses – one acting as a supplier/seller, while the other one is the purchaser. As there is no consumer element involved, it’s purely B2B.

Under the terms of a trade credit agreement, the purchaser gets the materials and equipment needed to support its business operations. The supplier/seller provides it at no immediate cost. Instead, the purchaser will have a defined period in which to make payment.

This type of commercial finance gives your business the freedom to make important purchases without needing to wait until you have all the money in place. It’s also often the case that no interest is charged on the total value. And that can be a real benefit to your cash flow.

Are there different types of trade credit?

On one level, the different types of trade credit can relate to the length of time that you’ll have to make payment. But it’s a solution that also has different technical levels, which are:

• Open Account: The name indicates how this type of trade credit works. A supplier/seller will send you the goods, together with an invoice. It’s a less formal type of trade credit as a result.
• Bills Payable: This is also called a commercial draft and is where a supplier/seller will draw an instrument for you to accept as the buyer. Ultimately, it means you’ll agree to pay what you owe by the expiry date.
• Promissory Note: This is a much more formal B2B agreement. As the buyer, you sign a document that says you agree to the terms – i.e., the payment date.

What can trade credit be used for?

You can use trade credit for numerous reasons. To an extent, it’ll depend on the supplier/seller you’re working with. After all, they could be specialists in a certain area and can’t provide your business with everything you need.

But there’s no reason why you won’t be able to find partners to provide you with things like:

−      Essential equipment upgrades to expand your business

−      New stock and products to diversify your current range

−      Replenishment of popular lines to satisfy your growing demand

How does trade credit work?

If you’re still unsure how this type of commercial finance works, perhaps an example will make it a lot clearer in your mind. Let’s say you’ve spotted there’s a gap in your market for a certain product. It could be the opportunity you need to take your business to the next level. But there isn’t enough cash at your disposal straight away to buy the stock.

With trade credit, a supplier could provide you with that stock on the promise (and expectation) that you’ll pay later. This is normally 30 days later. But the terms may stipulate 60, 90 or even 120 days. It depends on your supplier and the terms of your agreement. It gives you the space you need to raise the funds – whether that’s through product sales or otherwise.

The only thing you then need to think about is paying on time. Not doing so can incur penalties or interest. Worse still, you could make your suppliers less likely to offer you trade credit again.

Trade credit: Advantages and disadvantages

Are you thinking that trade credit offers your best chance of growing your business? Perhaps it will. But, like any financial decision, you should first weigh up the advantages and disadvantages to make sure it’s a suitable option.

Advantages of trade credit

−      It’s simple! Some other forms of commercial finance can seem overly complex and confusing. But one of the key benefits of trade credit is how clear it usually is.

−      It eases cash flow concerns. As 75% of SMEs say cash flow is the reason for seeking finance, trade credit can offer valuable breathing space as you build your business.

−      A track record of meeting your payments to suppliers in full and on time can boost the reputation of your business, helping you access credit more easily in future.

−      Survive or thrive, the nature of trade credit can be the difference between ensuring you’re able to sustain and grow your business in the short and long term.

Disadvantages of trade credit

−      Any form of credit comes with the expectation that you’ll pay on time and in full. If you don’t, high penalties and interest charges for late payment could cause real headaches.

−      Late payments also tarnish your business’ reputation. Suppliers might stop working with you – and that’s a real problem if you can’t get what you need to run your business.

−      For start-ups and newer businesses, it’s much harder to prove to suppliers that you can be trusted. So, any trade credit you’re offered may not turn out to be such a good deal.

−      A history of late payments never looks good on a credit report. It’ll make it even harder to secure funding in future, whether that’s a credit card or a small business loan.

Who qualifies for trade credit?

The short answer is that any business can conceivably qualify for trade credit. It is, however, a lot easier for more established companies to foster strong relationships with suppliers or sellers. The usual reason for this is that such companies already have a track record of meeting the terms of previous (or current) trade credit agreements.

Apart from that, there’s no need to operate in a specific sector to use trade credit. Construction firms, supermarkets, car repair centres, hospitality operators and more all have the potential to obtain what they need through this form of commercial finance.

Is trade credit the right option for me?

Time can be of the essence as a business – and, sometimes, finance is required sooner rather than later. But that’s no reason to jump straight into a credit agreement without being sure of the implications. Trade credit could be the right option for your business. Equally, there might be better solutions that are more in tune with your goals and circumstances.

Two of the main questions to ask yourself are:

• Can you pay what you owe within the terms of the agreement? If you have 30 days, how realistic is it that you’ll have the full amount ready to pay in that time?
• Are you likely to get trade credit on terms that suit you? For a newer business, it’s a major consideration. Is it worth less-favourable terms just to secure an agreement?

The alternatives to trade credit

By weighing up all your options, you should be able to secure a solution that’s most appropriate for your business. Trade credit isn’t your only avenue of opportunity. At Nucleus, for example, a wide range of alternative commercial funding options are available to support your ambitions.

What’s more, we’re experts when it comes to helping UK SMEs realise their potential.

If you have short-term cash concerns or long-term growth ambitions, get in touch with us now. Talk to one of our finance specialists to see how we can best support you. There’s no obligation when we provide your quote, but you may find that Nucleus is the option that’s right for you.