What is Trade Credit?
Companies that supply your business will often allow their customers a grace period before having to pay for the goods. This is called vendor or trade credit and it permits businesses to generate at least some revenue from the sale of goods before they have to pay for those goods. Vendors offer this credit to help attract new customers. The vendors can also purchase insurance on this credit to cover their risk.
A common phrase is “net 15” or “net 60,” which means you have 15 days or 60 days after purchase to pay for the items. Another common practice is to offer terms such as “1 percent 10 Net 30.” This means if you pay your invoice within 10 days, you get a 1 percent discount, or else the entire payment is due within 30 days. Essentially, trade credit serves as a short-term, interest-free loan.
Vendor credit can be easier to obtain than bank credit because it doesn’t require collateral, and bank business loans can require multiple vendor lines of credit.
As you get closer to needing supplies for your business, begin investigating possible vendors. Seek out suppliers who can serve most, if not all, of your needs. That way you’ll only need to work out terms with a few companies.
Draw up estimates of your expected inventory needs for the first year of operation and present those to potential suppliers. Stress that you are seeking a vendor for a long-term relationship. You can also share your projections for cash flow for the first year, as well as any other financial obligations your business has, in order to demonstrate your ability to cover payments.
Trade credit can take many different forms. Among them are quantity discounts, equipment loans and consignment sales (payment only when goods are sold).
As mentioned above, suppliers will often give businesses a form of trade credit through a small discount if the firm pays its invoices in a short period of time, such as 10 days. While this may be appealing to startups looking to save money, be careful when opting to take these discounts.
Cash is especially important to young businesses when revenues are low and expenses are rolling in. If you pay an invoice early for a 2 percent discount, you could be depriving your company of needed funds for other invoices with more imminent due dates, or be depleting your cash reserves right before an important loan application.
Do a thorough analysis on the medium-term benefits of taking trade discounts to ensure that it is not costing you more to make the early payment than to keep the funds for other uses. Trade discounts may be best used once your business has stabilized.
Also, be aware of any charges that could result from penalties related to late payments. About.com’s Guide to Retailing has more information on the cost of trade credit.
Building Other Forms of Credit
Business credit is typically broken down into several areas including: bank credit, credit cards, trade credit, leased equipment and financing your accounts receivable. In the early stages, your business credit may be linked to your personal credit history, so take the time to make sure that is in order. Check out About.com's resources for building your credit and credit repair.