What is Trade Credit?
Trade Credit – Its pros and cons!
For those that run a business, it is critical to know the pros and cons of trade credit whether it is for business supplies or customers. While there are obvious benefits there also are certain disadvantages that any business owner must be aware of.
Understanding Trade Credit
Trade credit occurs when any company or business offer a credit line for its services or goods. A business may utilise trade credit for purchases it makes by buying on credit and paying within a stipulated period stated in the supplier’s terms and conditions. Normal terms are usually around 30-45 days of date of invoice. Many businesses operate and use trade credit facilities and offer them to their customers. It is a far better option than the cash from a bank loan or overdraft, although there are often high-interest rates and penalties for delayed and overdue payments etc. It is a win-win for both the customer and the business with the former able to make purchases on credit and the latter providing their services and good immediately with awaiting for the cash payments or bank clearance of funds.
Herewith Let us examine a few of the pros and cons:
Benefits for buyers:
Beneficial for start-ups:
Newly formed companies finding it difficult to find investors and funding can benefit. The only issue may be qualifying for credit as they do not have any credit history.
In comparison to competitors that have to pay upfront in cash, trade credit makes it more competitive for businesses and offers more flexibility if they have limited cash funds at their disposal.
Good where cash flow is limited:
During periods when business is slow or there is a need to increase stock levels and cashflow is low trade credit can help to obtain volumes of stock which can be sold prior to the payment date of purchases, etc.
Disadvantages for buyers:
Can be difficult for new businesses:
While trade credit is ideal for start-ups with limited cash not having a credit history can prove difficult to obtain credit with some suppliers insisting on cash payment or initial purchases.
Risk of legal action:
For buyers who are unable to pay within the terms of the credit transaction there is a risk of legal action being taken against them.
If buyers fail to meet payment terms within a credit transaction there are always a risk of interest being charged.
Impact credit rating:
Failing to pay on time can result in legal actions and a court judgment being registered. This could seriously affect the credit rating of a business and result in trade credit being refused by other suppliers.
Advantages for sellers
Gain new customers:
When you offer trade credit to prospective customers it incentivizes them to buy more. It is a good way to increase business and become more competitive.
To promote better sales suppliers can combine trade credit with bulk discounts to encourage more purchases.
Gain loyal customers:
A business can effectively use trade credit to gain business loyalty among repeat buyers that will not purchase elsewhere because of the benefits they are getting from the business.
Disadvantages for sellers:
One of the biggest drawbacks of trade credit is the constant chasing for payments from buyers delaying payments. More invoices are paid later than the due date which can result in cash flow problems.
Risk of incurring bad debts:
An additional disadvantage is that of some customers may cease trading or disappear completely leaving outstanding debts that result in bad debt write offs.