Definition: An arrangement to buy goods or services on account, that is,
without making immediate cash payment
For many businesses, trade credit is an essential tool for
financing growth. Trade credit is the credit extended to you by
suppliers who let you buy now and pay later. Any time you take
delivery of materials, equipment or other valuables without paying
cash on the spot, you're using trade credit.
When you're first starting your business, however, suppliers
most likely aren't going to offer you trade credit. They're going
to want to make every order c.o.d. (cash or check on delivery) or
paid by credit card in advance until you've established that you
can pay your bills on time. While this is a fairly normal practice,
you can still try and negotiate trade credit with suppliers. One of
the things that will help you in these negotiations is a properly
prepared financial plan.
When you visit your supplier to set up your order during your
startup period, ask to speak directly to the owner of the business
if it's a small company. If it's a larger business, ask to speak to
the CFO or any other person who approves credit. Introduce
yourself. Show the officer the financial plan you've prepared. Tell
the owner or financial officer about your business, and explain
that you need to get your first orders on credit in order to launch
your venture.
Depending on the terms available from your suppliers, the cost
of trade credit can be quite high. For example, assume you make a
purchase from a supplier who decides to extend credit to you. The
terms the supplier offers you are two-percent cash discount with 10
days and a net date of 30 days. Essentially, the suppliers is
saying that if you pay within 10 days, the purchase price will be
discounted by two percent. On the other hand, by forfeiting the
two-percent discount, you're able to use your money for 20 more
days. On an annualized basis, this is actually costing you 36
percent of the total cost of the items you are purchasing from this
supplier! (360 ( 20 days = 18 times per year without discount; 18 (
2 percent discount = 36 percent discount missed.)
Cash discounts aren't the only factor you have to consider in
the equation. There are also late-payment or delinquency penalties
should you extend payment beyond the agreed-upon terms. These can
usually run between one and two percent on a monthly basis. If you
miss your net payment date for an entire year, that can cost you as
much as 12 to 24 percent in penalty interest.
Effective use of trade credit requires intelligent planning to
avoid unnecessary costs through forfeiture of cash discounts or the
incurring of delinquency penalties. But every business should take
full advantage of trade that is available without additional cost
in order to reduce its need for capital from other sources.