Trade Credit

What Is Trade Credit?

Fundamentally, trade credit is a B2B agreement between two parties, i.e. buyers and suppliers. As per such an arrangement, businesses can procure goods from their suppliers on credit, on the basis of specific terms of sale. 

Trade credit is, thus, more like an immediate form of investment, wherein, the approved credit limit is based on the following –

• Business requirements
• Current liabilities
• Current assets
• Buyer creditworthiness
• Repayment capacity

The trade credit forwarded by a firm to a customer, serves as an account receivable. Alternatively, it can be treated as a debt that does not accompany any interest burden or a 0% funding option that increases a company’s assets, while deferring its payments. 

Primary Characteristics Of Trade Credit:

These are among the prominent features of trade credit –

• Purpose - Generally, businesses avail this credit option to procure raw material, latest equipment, and to meet several other business-oriented requirements. In turn, it helps to keep business operations moving. 

• Cost Of Investment - Notably, there is no direct cost involved with trade credit. Nevertheless, businesses may be subject to a few indirect costs such as, loss of early pay-out discount, failure to adhere to terms of trade credit, expenses resulting from negative working capital, etc. 

• Time Frame - Buyers usually avail a time frame ranging from 30 days to 90 days to account for the credit, received under this funding option. This makes it an immediate cash funding option that can be availed for a short time. 

• Types - There are three types of trade credit – trade acceptance, open account, and promissory note.

How Trade Credit Works?

The terms of trade credit are formulated by the supplier or seller and emphasises on elements like the amount due and the repayment period. Notably, such features are discussed and agreed upon by both parties involved. Typically, suppliers may include details related to penalty charge, for late payment and discounts for repaying early. 

Once the trade credit is formulated, the supplier sends the buyer an invoice and the purchase order in question. The repayment tenure is usually set for 30 days; it can also range anywhere from 7 days to 120 days. The best way to secure trade credit is by building a clean payment history, providing trusted references, and improving credit rating. 

Suppliers often agree to extend trade credit to retain customers, and facilitate a better buyer-seller relationship. However, while extending goods and services on credit, businesses are often subject to working capital shortage or cash flow crunch. In such a situation, to inject more cash into their operating cycle, businesses can avail KredX’s invoice discounting services and access funds, typically within 24 hours to 72 hours*. 

Businesses can benefit from our integrated cash flow solutions by using unpaid account receivables to raise funds. Our invoice discounting services do not require the involvement of buyers to access funds, which in turn assures confidentiality and protects business. Nevertheless, it also maintains the customer relationship until the end. 

Benefits And Drawbacks Of Trade Credit:

• Advantages Of Trade Credit

The pointers below will help you to understand the advantages of trade credit –

• Trade credit helps to free tied-up capital.

• It is a relatively low-cost working capital solution.

• Trade credit helps to increase current assets.

• It does not increase immediate liabilities.

• This financing option accompanies easy to meet criteria and terms of repayment.

• Limitations Of Trade Credit

The common drawbacks of trade credit are as follows –

• Online retailers cannot avail this financing option.
• The accompanying penalty and interest pay-outs tend to increase the overall cost of availing funds.
• Start-ups may find it challenging to access such a kind of funding option.

Due to fear of default, late payments, or cash flow crisis, businesses may refuse trade credit to companies with poor repayment records. To avoid such an ordeal, companies can avail KredX’s invoice discounting services and use unpaid invoices to raise capital. 

Nevertheless, businesses should weigh the pros and cons accompanying different types of trade credit, before deciding to go forward with this funding option. By doing so, they will be better positioned to understand whether they are eligible to avail funding via trade credit or not.