Advantages and disadvantages of trade credit

A business trade credit is an arrangement between a buyer and a seller in which the buyer receives goods or services now and pays for them later.

Trade credit is often extended to businesses that purchase supplies or raw materials from other businesses on a regular basis. While trade credit can be a helpful way to finance purchases, there are also some potential drawbacks to this type of arrangement.

One disadvantage of trade credit is that it can be difficult to track expenses. Since payments are not made immediately, businesses may find it challenging to keep track of how much they owe.

Additionally, businesses that rely heavily on trade credit may find themselves in financial difficulty if their customers encounter financial difficulties of their own. Another potential downside of trade credit is that it can impact a business’s cash flow.

This is because businesses must still pay for their purchases even if they have not yet received payment from their customers. As a result, businesses that extended too much trade credit may find themselves in need of short-term financing to cover operating expenses.

Despite these potential drawbacks, trade credit can be a helpful way for businesses to finance their operations. When used wisely, trade credit can provide businesses with the capital they need to grow and expand their operations.

It is key that you understand both the advantages and disadvantages of trade credit, so that you can decide if you should offer it to customers or use it when buying supplies for your business.

Trade credit can be a truly positive factor for businesses, but it is not without its pitfalls and problems.

What is trade credit?

The first thing you need to know is exactly what trade credit is.

Trade credit is the act of one business giving a credit extension to another business so that it can purchase products and services. For instance, a garden landscaping business could utilise trade credit to purchase materials for a landscaping project, purchasing using a credit card and promising to pay inside a set term – generally 30 days.

As a business, you can offer trade credit to other firms and furthermore use trade credit facilities presented by other companies. Trade credit is less formal than a bank loan, however there are generally terms and conditions that go along with it, including punishments and interest for late payments. Trade credit is often a mutually beneficial course of action – clients can purchase merchandise using a loan, and providers can draw in more clients by not demanding cash up front.

Trade credit positives and negatives are different depending upon whether your business is the purchaser in the agreement and utilising trade credit, or a provider of trade credit. Prior to accepting trade credit, it’s ideal to know the up-sides and negatives of any agreement.

Advantages of trade credit for buyers

Although there are a few trade credit disadvantages for buyers, the advantages far outweigh them. Here, you will be able to purchase materials, goods, and services without having to pay up front or on delivery. The positive aspects range from accessibility and improved cash flow, to aiding new start-up ventures with getting off the ground.

Get a competitive edge

Purchasing products as required using a loan gives organisations an upper hand over rival firms that might need to pay up front. Utilising trade credit permits your business to be more adaptable, adjusting to market demands and seasonal requests with the goal that you have a steady stockpile of goods in any event, even when your funds aren’t stable.

No cash required upfront

With no need to pay cash up front, buyers can load up in time for peak demand, for example, submitting bigger orders to exploit key seasonal selling times like Christmas. Trade credit is a benefit as cashflow might be low coming off calmer months, possibly forestalling sufficient stock to be bought for more profitable periods.

Fuels business growth 

You should view trade credit as a kind of interest-free loan. As it effectively provides you with capital at no cost, it is without doubt one of the best ways to keep cash in your company. With it there will be less administration in comparison to arranging a short-term loan. Your venture is basically selling goods on behalf of the supplier, instead of using the cash reserves on stock, and gaining a profit while doing so.

Easy to arrange

On the off chance that your business has a decent history of credit, can meet a supplier’s requirements, and can settle on customary payments then, at that point, trade credit arrangements are normally simple to arrange and keep up with. There are not many formal plans or negotiations to complete, which makes this service fast and easy. 

Increases your business’ reputation 

Your company’s reputation will potentially rise to a greater level through the use of trade credit, as demonstrating your ability to make regular payments against credit is always a good thing. If you establish a positive trade credit history, suppliers may begin to see you as a preferred buyer. 

Discounts and bulk buying

Suppliers might offer engaging discounts to trade credit clients who pay early, making it a valuable method for acquiring a lower rate. Organisations with a decent trade record of loan repayment may be offered discounts, particularly for bulk buys, or exclusive access to goods and services.

Advantages of trade credit for sellers

When it comes to suppliers, trade credit is largely focused around winning new customers, increasing sales, and retaining customer loyalty.

Winning new buyers

Buyers tend to find trade credit favourable. It’s a convenient way to ease cashflow; something that can aid the improvement of a small business’s profitability. As a supplier, offering trade credit is a great method of winning over new customers, particularly if competitors demand upfront payment.

Sell more goods and services 

Providers can blend trade credit with bulk discounts to urge buyers to spend more. Assuming buyers rapidly sell out of stock, they are bound to return and purchase extra stock to satisfy customer need. This can place you in a never-ending cycle that will prove to be highly profitable.

Build on buyer loyalty

Supplier trade credit can put a stop to buyers looking elsewhere, and also help to strengthen the supplier-buyer relationship you have worked hard to create. Trade credit depends on trust between the two parties, great correspondence, and a commonly advantageous relationship that can build up loyalty over time.

Disadvantages to trade credit for buyers

There are certainly less downsides to trade credit for buyers than there are for suppliers, but it is still important that you understand them. For instance, even though trade credit may appear as a lifeline for your small business venture, you should opt to steer away from it if you aren’t going to be able to make repayments.

Difficult for start-ups to obtain

Trade credit seems like it should be the perfect solution for new companies. Access to stock without upfront payment could assist with getting your business fully operational. However, trade credit is essentially harder for new organisations to acquire, or it could be presented on restrictive repayment conditions. Until your business has laid down a good foundation for itself and developed a steady exchanging history, a few providers will be hesitant to offer your business trade credit.

Penalties and action

While you may view trade credit as ‘free money’ which can be reimbursed without interest, this will not be the case if you miss a repayment. Most trade credit agreements include penalties for late payments and interest payable for outstanding credit. This can soon spiral into huge expenses if your business doesn’t attempt to clear trade credit debt.

Loss of suppliers

When confronted with a poor-paying buyer, suppliers might be enticed to pick up and move on and decline to work with your business. Providers can reassess working with you, leaving your business incapable to work or fulfil client need – conceivably bringing about the closure of your business.

Disadvantages of trade credit for suppliers

There are absolutely risks attached to trade credit for suppliers, there is no getting around that fact. While there are loads of courses open to deal with problem buyers and getting back the cash your business is owed, these can be tedious and exorbitant – possibly affecting your cash flow and leading to monetary issues.

Late payments and cash flow issues

As we have already touched upon, late payments can be a huge problem here. Buyers simply refusing to pay at all is another issue within this area that should concern you. For instance,  CreditSafe state that more invoices are paid late than on time.

Suppliers have the need to pay their own bills, staff wages, etc. So, if you are not paid on time you can begin to face huge cash flow problems. Guarantee your business has a solid cash reserve and doesn’t overstretch using a loan. Offering discounts to buyers who make early repayments can likewise assist with easing cashflow issues brought about by late payers.

Bad Debt 

It is one thing to face late payments, yet non-payment can introduce a genuine test. Clients utilising trade credit might go out of business or payment may essentially be too hard to even think about chasing down, and that implies your company should discount the misfortune as an awful obligation. It merits exploring trade credit protection, which can guarantee your business for bad debt brought about by defaults on trade credit arrangements.

Customer assessment

Providing trade credit is a demonstration of trust. Evaluating whether a client can reimburse you merits doing right yet deciding a buyer’s credit worthiness can consume a lot of time. You’ll have to look at references, get credit reports and audit trading history – all of which requires some investment.

Conclusion