Besides selling its products/services, building a strong credit score is what every small business owner needs to focus on, to deal with cashflow issues and ensure steady growth in today’s highly-competitive business environment. A business requires external financial support at different phases of its entrepreneurial journey. Business finances help entrepreneurs to cope with cash flow issues, pay for emergency machinery/equipment repairs, urgently hire extra staff to efficiently handle seasonal demands, purchase inventories or stock up the latest on-demand collections, make payments of existing debts, expand their businesses or to just get through the tough times.

However, it is not always easy to acquire business finances as some lenders, especially traditional ones like banks have high credit score requirements. Hence, start-ups or small businesses with less trade history and low credit scores find it difficult to qualify for business loans and often wonder how to build an appreciable credit score. For entrepreneurs, who have recently stepped into the industry and looking to build a strong credit history, that can easily fetch them long-term business loans of big amounts in the future, trade credit can turn out to be quite helpful. Now, what is a ‘trade credit’? To be precise, trade credit allows businesses to get the needed goods/services supplied to them now and pay on a future date, which is usually decided by the trade credit providers i.e., the suppliers/vendors. This is extremely beneficial for business owners, especially those who trade in the construction, fashion, food, and retail industry, as they receive the required supplies on time, even if they don’t currently have cash in hand but expect to get multiple invoices cleared in some time. Trade credits come with short repayment terms, which usually range from two weeks to 4 months. But, a net 30 deal, which allows the borrower to pay the dues within 30 days of the invoice date, is the most popular trade credit term.

A business owner looking for business finance must understand his/her company’s primary needs, analyze its current financial condition and evaluate its growth opportunities, before choosing a financing option. This is because every business has unique requirements and each lender has unique credit score requirements and offers different interest rates and loan terms. Bank loans come with low-interest rates but high credit score requirements and a tedious application process. Nonetheless, in the case of alternative financing options like MCA(Merchant Cash Advances), though the interest rates are comparatively higher, the credit score requirement is lower, the application process is simpler as well as quicker and the approval generally comes on the same day of the application. Unlike the above-mentioned financing options, trade credit, which is also known as supplier’s credit or mercantile credit, involves little or no interest. However, before applying for trade credit, finance seekers must get a clear understanding of its hidden costs, which are: The cost of a sash discount and the cost of late payments. Vendors sometimes offer discounts on the due amount if it is cleared within a specific time, which is generally shorter than the usual repayment term. If the borrower chooses to forgo the discount and pay on the regular date due to the unavailability of cash at that moment, technically, he/she is paying extra money for the same goods, which would have cost less if the payment was made earlier.

Example:

An entrepreneur purchases goods with a trade credit of $2,000 and a net-30 payment term, but gets a discount of 5% on the due if cleared within 10 days instead of 30 days. In such a scenario, if he/she takes the vendor’s discount offer, he needs to pay $1900 (2000 – 5% of 2000{100} = 1900), and if he/she refuses to take the offer, he needs to pay an extra $100 for the same goods. Hence, $100 can be considered the cost of financing.

On the other hand, late payments turn out to be quite expensive for the buyers. This is because late payment penalties, which vary with vendors, can go as high as 15% or more if the payment is not made within the pre-decided date. Also, late payments seriously affect the buyers’ business credit scores as the vendors often report the defaults to the commercial credit bureaus.

Primary Benefits of Trade Credits:

Trade credit providers offer business owners goods now and allow them to pay the amount on a later date, which generally comes after 30 days the invoices are raised. As a result, entrepreneurs get a chance to continue trading uninterruptedly, even when they are waiting to get some of their invoices cleared and ensure constant cash flow.

Trade credits help to build or increase credit scores when the buyers, regularly, make payments on or before the pre-decided payment date. Suppliers, who are satisfied with time-to-time payments, submit positive reports to the commercial credit bureaus. As a result, the buyers’ credit scores get boosted.

Also, timely payments make the buyers trustworthy in the eyes of the suppliers or trade credit providers. This makes the suppliers extend their credit terms. As a result, the business owners get more time to improve the income of their businesses and arrange money to pay the debt.

Some vendors don’t ask for an established business credit history to offer trade credits. Hence, it is considered one of the most convenient financing options for small companies or start-ups. Also, some trade credit providers don’t check personal credit.

Trade credits are a cost-efficient and easier solution for businesses as most suppliers/vendors don’t charge interest fees on trade credit accounts. Hence, it is often recommended by SBA(Small Business Administration) to entrepreneurs looking to build business credit for the first time.