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How to Determine If Trade Credit Is Right For Your Business
May 07, 2021
Trade Credit Is It the Right Funding Option for Your Business

How to Determine If Trade Credit Is Right For Your Business

If you own or manage a small business, there’s a good chance you’ve faced cash shortages within the past year due to the COVID-19 pandemic. Cash shortages can make it very challenging for you to buy inventory and supplies, and can even threaten your business’s longevity.

In some cases, when business owners find themselves low on cash flow, they’ll pursue trade credit. With this business financing option, you can receive the goods or services you need and pay for them by an agreed upon date. In this post, we’ll take a closer look at this type of financing so you can determine if trade credit is right for your business.

Trade Credit Definition:

Trade credit can give you the opportunity to buy what you need from various vendors and pay them at a later time. If you receive a trade credit, you’ll have anywhere between 30 and 120 days to take care of your balance.

Depending on the vendor, you may score a discount if you pay for your purchase before it’s due. However, if you don’t pay your balance by the due date, you may be on the hook for costly late fees.

Trade Credit Terms:

If you use trade credit, you can expect an invoice with net terms. The net terms will determine how long you have to pay the vendor back. While every vendor has its own unique trade agreement, most include the following net terms:

  • Net 30: Your payment is due within 30 days of the invoice date.
  • Net 45: Your payment is due within 45 days of the invoice date.
  • Net 60: Your payment is due within 60 days of the invoice date.
  • Net 120: Your payment is due within 120 days of the invoice date.

Your trade credit agreement should also explain what happens if you make a late payment and whether you’ll get a discount for paying off your balance earlier than the set due date. You should be aware of any payment penalties or other potential fees before taking out trade credit.

The Pros of Trade Credit

The greatest benefits of trade credit financing include:

  • Relief From Cash Flow Issues

If you’re short on cash flow, trade credit can give you some peace of mind. You’ll still be able to get the inventory and supplies you need to run your business.

  • Easy Qualification

In most cases, vendors will approve you for trade credit. This is particularly true if you have a positive track record and have been in business for a while. Fortunately, it won’t take long to apply for trade credit and receive your goods.

  • No Interest

As long as you pay your bill before the predetermined due date, you won’t have to worry about interest or extra fees.

  • Customer Satisfaction

With trade credit, you can ensure your customers receive what they want, when they want it. If you’d like to land new customers and keep loyal ones, this financing option can help.

  • Positive Long-Term Relationships

Trade credit can help you build strong, long-term relationships with vendors. These vendors may offer competitive prices and favorable terms.

Trade-Credit

The Cons of Trade Credit

Before you use trade credit, be cautious of these drawbacks.

  • May Be Expensive:

If you use trade credit, you won’t qualify for early payment discounts. Depending on the vendor, you may be stuck with expensive prices.

  • Late Fees:

In most cases, if you don’t pay off your balance on-time, you’ll be charged a late fee. While late fees vary from vendor to vendor, some can 10% to 15% of your balance.

  • Credit Issues

Late payments can take a toll on your business credit score. With poor credit history, you’ll find it difficult to land financing with low rates and favorable terms.

  • Damaged Relationships

If you fail to make your payments on time, you can ruin your relationships with vendors. This may force you to look elsewhere for inventory and supplies.

Trade Credit vs. Business Loans and Other Funding Options

Compared to other funding options like business loans and credit cards, trade credit may be easier to obtain. It may also be more affordable if you pay your balance by the due date as there are no interest charges involved. If you go with a traditional loan or cash advance, you’ll have to pay interest to borrow money.

The benefit of other funding options like loans, credit cards, and cash advances, however is that you can receive money to cover just about any expense or investment. If you’re short on cash but need to pay your employees, for example, you won’t be able to with trade credit. Trade credit is typically reserved for inventory and supplies. This makes other funding options more flexible.

In addition, other forms of funding come with longer repayment terms. For example, you can take out a business loan with a 5 year term. Because of this 5-year term length, you won’t have to pay the loan amount back immediately. If you opt for trade credit, you may only have 30-60 days to pay off your balance.

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Conclusion: Weigh Your Options When Considering Trade Credit Financing

Trade credit can benefit you as a small business owner, especially if you have cash flow issues that inhibit your ability to buy the inventory and supplies you need to operate. You’ll receive an interest-free loan that may help you avoid the traditional expenses that come with borrowing money. If you need cash to cover anything other than inventory and supplies or need longer repayment terms, you may want to consider alternative funding options.

Fora Financial

Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.

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Fora Financial is a working capital provider to small business owners nationwide. In addition, the Fora Financial team provides educational information to the small business community through their blog, which covers topics such as business financing, marketing, technology, and much more. If you’d like to see a topic covered on the Fora Financial blog, or want to submit a guest post, please email us at [email protected].