Trade Credit

Normally, a supplier will extend you credit after you're aregular customer for 30, 60 or 90 days, without charging interest.For example, suppose that a supplier ships something to you, andthat 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 whichcase you would have 30 extra days to pay for the items.

However, when you're first starting your business, suppliersare not going to give you trade credit. They're going to wantto make every order C.O.D. (cash or check on delivery) untilyou've established that you can pay your bills on time. Whilethis is a fairly normal practice, to raise money during thestart-up period you're going to have to try and negotiate tradecredit with suppliers. One of the things that will help you inthese negotiations is a properly prepared financial plan.

When you visit your supplier to set up your order during yourstart-up period, ask to speak directly to the owner of the businessif it's a small company. If it's a larger business, ask tospeak to the chief financial officer or any other person whoapproves credit. Introduce yourself. Show the officer the financialplan that you have prepared. Tell the owner or financial officerabout your business, and explain that you need to get your firstorders on credit in order to launch your venture.

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

Despite the urge to use trade credit on a continual andconsistent basis, you should consider it as a source of capital tomeet relatively small, short-term needs. Do not look at it as along-term solution. By doing so, you may find your business heavilycommitted to those suppliers who accept extended credit terms. As aresult, the business may no longer have ready access to other, morecompetitive suppliers who might offer lower prices, a superiorproduct, or more reliable deliveries.

The Cost Of TradeCredit

Depending on the terms available from your suppliers, the costof trade credit can be quite high. For example, assume you make apurchase from a supplier who decides to extend credit to you.

The terms the supplier offers you are two-percent cash discountwithin 10 days and a net date of 30 days. Essentially, the supplieris saying that if you pay within 10 days, the purchase price willbe discounted by two percent. On the other hand, by forfeiting thetwo-percent discount, you are able to use your money for 20 moredays. On an annualized basis, this is actually costing you 36percent of the total cost of the items you are purchasing from thissupplier! (360 days divided by 20 days = 18 times per year withoutdiscount; 18 times a 2 percent discount = 36 percent discountmissed.)

Cash discounts aren't the only factor you have to considerin the equation. There are also late-payment or delinquencypenalties should you extend payment beyond the agreed-upon terms.These can usually run between one to two percent on a monthlybasis. If you miss your net payment date for an entire year, thatcan cost you as much as 12 to 24 percent in penalty interest.

Effective use of trade credit requires intelligent planning toavoid unnecessary costs through forfeiture of cash discounts or theincurring of delinquency penalties. But every business should takefull advantage of trade credit that is available without additionalcost in order to reduce its need for capital from othersources.