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Advantages and Disadvantages of Trade Credit

by jcp
gawdo

By Alan Bradstock, chartered accountant and insolvency practitioner with Company Debt.

Since the ability of any business to thrive rests upon its cash flow, trade credit can be a lifeline. In fact, it’s become a fundamental part of B2B sales culture with over 50% of companies using it.

In a typical scenario, suppliers will offer you thirty or sixty days ‘credit’ before you have to pay for goods. But as with any form of finance, there are pitfalls.

 We’ll help you explore whether trade credit is right for your business below.

What are the Advantages of Trade Credit?

  • It is Informal – Unlike a loan from a bank, which may come with the requirement for a personal guarantee, trade credit is relatively informal. There will be paperwork to sign, and penalties for not paying within the agreed time frames but it’s still a far simpler means of increasing cash-flow than dealing with a traditional financial institution.
  • Helps Build a Credit Score – As an accessible form of finance, trade credit is an ideal way for small businesses or start-ups to improve their credit score. Since many suppliers report of all their payment experiences to business credit bureaus, keeping to the terms and conditions of your agreement will result in a higher credit rating over time.
  • Establishes References – Over time, successful trade credit relationships will mean you can ask suppliers for a positive reference. This can improve your ability to build new supplier relationships and expand your business.
  • Frees up Working Capital – Perhaps the biggest advantage is the fact that capital, which you might otherwise have tied up in materials, is free for other areas of the business.
  • Increases your purchasing power – If you’re a business with major growth potential that can’t be realised due to an access of capital, trade credit can catalyse growth. With increased purchasing power that doesn’t require additional capital, you can grow your business faster.

What are the Disadvantages of Trade Credit?

  • Can be Out of Reach for Start-ups – While having a lower barrier to entry than bank finance, trade suppliers still have their own due diligence processes to go through before agreeing to a line of credit. As such, brand new businesses may be refused trade credit until their business has a certain amount of trading history.
  • Penalties – Like any finance, transgressing agreed repayment time frames will result in interest payments and penalties. If not addressed, your business could find that the same thing that was helping cash flow is now hampering it, as you face spiralling costs
  • Legal Action – In the worst-case scenario, not paying trade credit could give rise to legal action in the form of statutory demands, CCJ’s or a winding up petition.
  • Credit Rating Repercussions – Just as regular repayments improves your corporate credit, the opposite holds true. If you fall into payment arrears on your trade credit agreements, your credit score will take a hit.
  • Losing a Crucial Supplier – As with any business agreement, a failure to keep to agreements erodes business trust. Suppliers will often refuse to work with those who haven’t repaid them promptly meaning that you could lose a supplier vital to the running of your business.
  • Reputational Damage – In an age of online reviews, businesses must be even more cautious about maintaining a positive public profile of their culture and trading activities. Failing to keep trade credit agreements could result in poor reviews from suppliers or other forms of reputational damage.

Is Trade Credit Right for You?

Much as with a ‘buy now, pay later’ offer on a family sofa, trade credit is something you’ll need to approach cautiously lest you tie yourself into an agreement that may come back to haunt you.

When used appropriately it can be one of the best ways possible to expand a business, increase your sales figures, and build credit and reputation.

Our advice is to use it if your financial advisor or account confirms it’s the right choice for your business.

Author Bio:

Alan Bradstock is a chartered accountant and insolvency practitioner with Company Debt. He has four decades experience helping company directors find positive solutions to business challenges.

www.gawdo.com

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