Companies can enhance customer relationships by allowing for flexible payments on purchases. As a business owner, you might see this as a disadvantage – selling products without immediate payment. However, with a firm understanding of trade credit, companies can leverage this service for payoff in the long-term, in more ways than one. Learn more about the advantages and disadvantages of trade credit in the following guide, beginning with our trade credit definition.
Trade credit definition
Trade credit is a type of financing that allows customers to pay for purchases over time. It is a business-to-business (B2B) agreement in which a company offers deferred payment at no interest during a defined repayment period. Also known as a line of credit, the transaction of goods and services purchased is recorded by invoice, and buyers typically have from one to three months to pay. The length of the repayment period is set by the supplier, but sometimes the buyer can negotiate for longer repayment terms.
The advantages of trade credit
The advantages of trade credit for buyers are numerous. First, it offers easy access to affordable financing as there is no interest charged during the repayment period. Using a line of credit for purchases improves the cash flow of a business, which is especially helpful for new start-ups. The use of trade credit can help establish and improve a business profile as well as build relationships with vendors.
Suppliers offering trade credit financing enjoy the rewards of a strong relationship with buyers. Moreover, such commercial finance agreements encourage customer loyalty. It leads to repeat business and higher sales volumes due to the fact that no interest is charged. It’s also a way to garner more business and remain competitive.
The disadvantages of trade credit
The disadvantages of trade credit are more numerous for suppliers.
First, offering commercial lines of credit requires a company to get legal support determining the terms and conditions of trade credit agreements and account handlers to deal with the paperwork and administrative tasks involved. Lines of credit place a heavier demand on accounting departments, too. There is also an inherent risk in offering trade credit to buyers, and a business may incur bad debt when, inevitably, some customers are unable to meet payment deadlines or are unable to make good on the amount owed. When this occurs at a time when cash flow is tight, it may be hard for a company to meet its operating expenses, as revenue is delayed or lost.
Even though lines of credit are generally advantageous for customers, there are some disadvantages for buyers using trade credit for purchases. One disadvantage is that a buyer’s credit score may be negatively impacted by the reporting of delinquent payments. Interest fees and penalties may be applied for late payment, and in some cases, legal action may be taken. And all of this can lead to the loss of suppliers, put relationships with other vendors in jeopardy, and mar a company’s public profile.
Trade credit insurance
Companies offering lines of credit may want to consider the purchase of trade credit insurance. Suppliers with trade credit insurance are protected from the main risk of trade credit agreements: nonpayment. Different types of products are available to protect your business, including:
Top-Up (credit complete)
Furthermore, due to the coronavirus pandemic, The Trade Credit Reinsurance Scheme was put forth to ensure that trade credit insurance coverage and credit limits are maintained. Extended until June 30, 2021, and backdated to April 1, 2020, the scheme includes information pertaining to eligibility, the application process, and reporting requirements. Businesses seeking advice on their trade credit insurance needs may contact to speak with a participating insurer or insurance broker.
We can help
GoCardless helps you automate payment collection, cutting down on the amount of admin your team needs to deal with when chasing invoices. Find out how GoCardless can help you with ad hoc payments or recurring payments.