Are You Taking Advantage of Trade Credit?
Trade credit is one of the most common sources of financing for small businesses. Vendors are often willing to issue credit terms, extending payment periods and typically providing a discount as an incentive for paying early. Trade credit terms grant businesses increased flexibility and, if cash flow allows, regular savings.
When cash flow is tight, utilizing prolonged payment terms can help businesses meet their obligations without jeopardizing their solvency. When cash flow is flush, the discounts offered for early payments can add up to significant savings over time.
These terms are particularly helpful in times when bank credit is less readily available, effectively substituting business-to-business financing for traditional lines of credit.
Understanding Trade Credit
Trade credit is conventionally expressed as 3 numbers, such as “2/10/30”. This series of numbers signifies discount terms as well as the length of the payment period. In this instance, “2/10” signifies that a 2% discount is available if the balance is paid within 10 days, while the final number, “30,” is the number of days you have to pay the balance off in full. The same terms can also be expressed “2/10, net 30.”
Net payment terms are commonplace on vendor invoices, but you may have to request an early-payment discount. Paying vendors early improves their cash flow, so they already have an incentive to provide such terms. Likewise, if you’re willing to pay upfront for several months of goods or services, you may be able to negotiate a discount for doing so.
The Benefits of Trade Credit
Trade credit is not only more accessible for small businesses than financing from banks, it can also help build business credit, which may eventually improve eligibility for bank financing. Historical payment behavior is one of the primary factors that lenders consider before issuing business credit.
Establishing a strong record of timely payments through your relationships with vendors helps demonstrate your ability to pay off your debts. Successful relationships can also yield trade credit references, which are similarly useful in the credit application process.
Even if you never seek financing from banks, the flexibility and savings offered by trade credit terms can improve your bottom line. While discounts of 1% or 2% may seem negligible, in the long-term, they cut costs and improve profitability. Taking advantage of trade credit with several vendors can multiply these effects.