How to Lower the Risks Associated with Trade Credit

Trade credit has several benefits for both customers and sellers who issue it, but it also has many risks associated with it. Businesses might feel tempted to adopt a trade credit program to help get new customers and land bigger orders while sellers should take steps to lower the risks associated with this option.

What Is Trade Credit?

Trade credit is a form of business financing that allows customers to obtain inventory and pay for their purchase at a later date. Trade credit is referred to as vendor credit or “net terms” and is a practice seen amongst B2B companies. When offering trade credit to customers, they will agree to a payback date that lasts between 30 and 120 days.

Trade credit can be a draw to some customers and can help some businesses sell more orders. For small business owners, trade credit can help them bridge cash gaps and grow their business. There are some serious risks associated with offering trade credit that businesses and customers should avoid.

When Payment is Too Late

The largest risk a seller faces by offering trade credit is that they may not get payment from their customers. Followed by the inconvenient, and potentially financially devastating, fallout of late payments. While offering trade credit will always pose some risk, having a thorough vetting process for customers can help improve the odds of working with a responsible borrower. Sellers can choose to hire a firm or a contractor that specializes in vetting a customer’s creditworthiness.

The main risk that the customer faces when applying for trade credit is not being able to pay back the financing on time. Late payments can result in late fees. Defaulted payments can lead to a painful and taxing debt collections process. To lessen these risks, businesses should only take out trade credit if they are sure, they will be able to make their payments on time.

When Payment is Too Early

While it may seem like receiving a payment late, or not receiving it at all, should be the lender’s main concern, receiving a payment too early can also be damaging. Many trade credit programs offer early payment discounts which can lead to thinner margins for the seller. Customers that take advantage of the benefits grained from responsibly using trade credits, should strive to take advantage of early payment discounts.

Early payment discounts are an incentive offered by the seller to attract customers but doing so means losing some profit. Even if the early payment is small, the discount can add up if multiple people take advantage of them. Discounts can cause confusion too because they can complicate financial projections as well. Sellers should consider avoiding offering early payment discounts if possible.

The Bottom Line

Trade credit can give both parties benefits but it can also stall the growth of the business. Giving customers inventory before accepting payment can cause cash flow risks. If a customer doesn’t pay on time, the seller may find they struggle to pay their own bills. Having a backup source of funding such as a credit card or business line of credit might provide some peach of mind and emergency funds.