Understand How Trade Credit Funding Works and Its Cost
The business-to-business or B2B model makes use of trade credit, which is a simple financing arrangement between two parties. In manufacturing sectors and the wholesale market, two parties agree on a transaction without instant payment. It is also called net terms or vendor credit.
Small business owners must be aware of trade credit and how it works to make an informed financial decision. In trade credit, the buyer can buy products or services with an agreement to pay later on a mutually agreed date like within 30 to 45 or 90 days. This is an informal credit relationship between customers and vendors, where small businesses can order raw materials or inventory for sale without the need to pay immediately. The small business owners achieve sufficient time to sell, generate revenue then repay the vendor.
Trade credit – Pros and Cons
Niche Trade Credit firm offers great protection to sellers dealing with international customers. During insolvency, political events, and many such problems can pose a hindrance to business prospects when the debtor cannot pay. NTC helps the cash flow and manages the financial health of your overall health. So, approach NTC brokers for debtor insurance as they have an experience of 30 + years and unique ability to recover the debts.
- Ease of access for startups and even businesses with a low credit score.
- Affordable as long as the invoices are paid on time.
- Smooth up your cash flow, which can be used for other core purposes.
- Enhance your business credit.
- Builds relationships with vendors that can lead to discounts and better pricing down the road.
- Is costly, if you cannot make payment on time [late fees are steep].
- Invoice not paid on time can damage your business score.
- Late payment history can hurt your relationship with suppliers.
Trade credit costs
For timely payments
Trade credit cost depends on timely payments and enjoys prompt payment discounts. On trade credit, vendors generally issue discount terms on the net 45 or net 30 invoices to shore their personal on-hand cash and enhance cash flow. It is a percentage for prompt invoice payment or cash on delivery. For example, net 30 means you can pay within 30 days of the invoice date. 3/10 means, you will gain a 3% discount if the vendor gets payment within 10 days of credit issuance. These discounts tempt you to pay promptly.
For late payments
Trade credit funding option is also associated with late payment penalties. Late payment penalties are also included in the invoicing terms. Even if you extend trade credit, it will include late payment fines. The penalties are steep on overdue invoices ranging as high as 10% to 15%.
It is wise to call the vendor and let them know your situation before the invoice due date to ensure that your relationship stays intact. Vendors are understanding and will offer a suitable solution. If you are extending trade credit, then be upfront with your customers about delayed payments, so they can work towards avoiding any problems.
You can leverage on trade credit business funding but ensure to find a small vendor with better terms, choose order quantities accurately, never place orders very early, and keep cash reserve to cover a minimum of one month’s accounts payable including trade credit payment.