Trade Credit

For many businesses, trade credit is an essential tool forfinancing growth. Trade credit is the credit extended to you bysuppliers who let you buy now and pay later. Any time you takedelivery of materials, equipment or other valuables without payingcash on the spot, you’re using trade credit.

When you’re first starting your business, however, suppliersmost likely aren’t going to offer you trade credit. They’re goingto want to make every order c.o.d. (cash or check on delivery) orpaid by credit card in advance until you’ve established that youcan pay your bills on time. While this is a fairly normal practice,you can still try and negotiate trade credit with suppliers. One ofthe things that will help you in these negotiations is a properlyprepared financial plan.

When you visit your supplier to set up your order during yourstartup period, ask to speak directly to the owner of the businessif it’s a small company. If it’s a larger business, ask to speak tothe CFO or any other person who approves credit. Introduceyourself. Show the officer the financial plan you’ve prepared. Tellthe owner or financial officer about your business, and explainthat you need to get your first orders on credit in order to launchyour venture.

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. Theterms the supplier offers you are two-percent cash discount with 10days and a net date of 30 days. Essentially, the suppliers issaying that if you pay within 10 days, the purchase price will bediscounted by two percent. On the other hand, by forfeiting thetwo-percent discount, you’re 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 ( 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 inthe equation. There are also late-payment or delinquency penaltiesshould you extend payment beyond the agreed-upon terms. These canusually run between one and two percent on a monthly basis. If youmiss your net payment date for an entire year, that can cost you asmuch 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 that is available without additional costin order to reduce its need for capital from other sources.