What is Trade Credit?

Businesses looking for short-term finance are often faced with obstacles that restrict them. The funds they require to run their business smoothly are hard to come by, and hence, they need to assess the available options.

If they are fortunate enough, they manage to acquire the required funds, but small business financing can be a difficult road for most businesses. That’s why they need a way to grow their business without the constant demand for money. Such a thing may seem impossible, but there is an opportunity that can help them achieve this goal. Want to know what the secret is?

Two words. Trade Credit!

This is most probably the easiest short term financing option available for businesses. So what does it entail?

Well, the concept of trade credit is simple. The general rules of trade require people to buy goods and services by paying for them. However, trade credit has made things easier for businesses. Now, they have the feasibility of buying goods and services without the need to make any immediate payments. The immediate relief this common business financing method provides to the businesses can make all the difference for them.

Sometimes, the helpful tool is all that businesses need to grow, so there’s no denying the benefits that this resource can provide. Once favorable terms have been arranged with the business’s supplier, the deal is good to go.


Understanding the Concept of Trade Credit

Now that you have a basic idea of what trade credit is, it’s time to explore it in detail. If you are a business that requires short term financing, you now know about a viable option. There are a few elements to the concept that you need to understand before you opt for this facility to help run your business.


Trade Credit Terms

There’s no strict standard for the terms and duration of trade credit. So it’s fair to say that most businesses create their own terms and conditions. The most common type of trade credit has a duration period of 7 – 120 days. At the discretion of the business, the terms can be managed and extended to suit both the parties.

The credit period is determined after taking into consideration a number of elements. When setting a credit period that benefits both sides, it’s important to reflect on the probability of payment default. If the credit receiving business belongs to a high-risk market, the firm providing the credit is likely to offer terms that are restrictive and a bit stricter than the ones offered to other businesses.

Common credit terms are net-30, net-45 or any other period of days. Net-45 means the payment is due in 45 days after your goods are sold or you’ve rendered services. The 45 days include weekends and holidays. Often, companies offer an early payment discount to encourage their customers to pay early, usually in 15 days or less,  For example, a business might offer a 2% discount if the customer pays within 15 days, rather than waiting the full 45 days. This would be referred to as 2/15 net-45 days terms of credit.


Basis for Trade Credit

Another factor that companies evaluate and base their decision on is the amount of the account. Most small accounts are more costly to manage, and so they receive shorter credit periods from a majority of businesses. The larger the account, the longer credit period they get. The last factor that businesses consider before finalizing the trade credit terms is the nature of the products. If the goods are perishable, then a shorter term credit period is preferred. The higher the collateral value of the goods, the higher the credit and the credit period is also longer.

As already mentioned, these described terms are not the set standards of the industry. These terms and conditions vary from business to business, even within the same industry. It’s better to get complete information from the granting firm beforehand to avoid any hassle later on.


Terms of the Sale

The terms of the sale define all the set conditions that both parties have decided on mutually. These terms are decided beforehand and discussed thoroughly by both the parties. They mention the period of trade credit. If there are any cash discounts involved in the transaction, they are also included in the terms of the sale. Another important element mentioned in the terms of sale is the credit instrument that is used for the transaction. Once the transaction is complete, the trade credit appears as accounts payable for the receiving firm, while the company that extended their services to provide credit notes down the transaction as accounts receivable.


Credit Instrument

In most cases of trade credit, an open account is used as the instrument. The invoice of the delivered goods is the only evidence that is needed for the transaction. There are some cases where the firm may ask for a promissory note to complete the transaction. However, this is only liable in cases where the firm anticipates a problem or the order is quite large.

Since there aren’t usually contracts included in the process, a promissory note acts like one. However, there is a problem with this system. Since the note is signed after the delivery of the goods, it can leave the granting firm hanging. A quick fix for this issue is to get a commercial draft.


Invoice Factoring

Trade credit is a savior for most businesses, but it can also cause the granting business some trouble. When accounts receivable become outstanding for long periods of time, businesses can run out of cash for operating capital. Trade credit can drain your cash account and create working capital shortages. Fortunately, factoring companies can help you get paid immediately, instead of waiting for your customers to pay. Contact a Texas factoring company and sell your invoices for immediate cash.

Want to know more? Contact Mazon Associates!

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Mazon has been providing factoring services for more than 45 years. We’ve helped thousands of businesses achieve their financial goals and keep their dream alive.

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