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Trade Credit

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Normally, a supplier will extend you credit after you're a regular customer for 30, 60 or 90 days, without charging interest. For example, suppose that a supplier ships something to you, and that bill is due in 30 days but you have trade credit or terms. Your terms might be net 60 days from the receipt of goods, in which case you would have 30 extra days to pay for the items.

However, when you're first starting your business, suppliers are not going to give you trade credit. They're going to want to make every order C.O.D. (cash or check on delivery) until you've established that you can pay your bills on time. While this is a fairly normal practice, to raise money during the start-up period you're going to have to 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 start-up 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 chief financial officer or any other person who approves credit. Introduce yourself. Show the officer the financial plan that you have 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.

The owner or financial officer may give you half the order on credit, with the balance due upon delivery. Of course, the trick here is to get your goods shipped to you, and sell them before you have to pay for them yourself. You could borrow the money to pay for your inventory, but you would have to pay interest on that money. So trade credit is one of the most important ways to reduce the amount of working capital you need. This is especially true in retail operations.

Despite the urge to use trade credit on a continual and consistent basis, you should consider it as a source of capital to meet relatively small, short-term needs. Do not look at it as a long-term solution. By doing so, you may find your business heavily committed to those suppliers who accept extended credit terms. As a result, the business may no longer have ready access to other, more competitive suppliers who might offer lower prices, a superior product, or more reliable deliveries.

The Cost Of Trade Credit

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 within 10 days and a net date of 30 days. Essentially, the supplier 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 are 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 days divided by 20 days = 18 times per year without discount; 18 times a 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 to 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 credit that is available without additional cost in order to reduce its need for capital from other sources.

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