Trade credit is akin to PayPal’s Bill Me Later
There’s nothing quite like the feeling of being able to buy something and not being required to pay for it until a later date. This is one of the reasons why credit cards and PayPal’s Bill Me Later (which I love) are so popular – they entice consumers to go ahead and make a purchase in good faith that they will pay it back.
Businesses often do something similar to this in the form of trade credit, in which a customer or business is allowed to make a purchase on account without submitting payment that day; the supplying company will extend a credit to that account for a specified period of time – usually at least 30 days – during which the purchaser must repay the amount owed.
This timeline is decided upon by the supplier company, and is usually based on how long they can successfully continue operations without remitting payment for those goods. These businesses must constantly keep cash flow in mind as purchases made on trade credit will decrease inventory levels with no immediate resulting increase in profits. Some businesses models are able to handle this delayed profit remittance, but it may be troublesome for companies that need substantial amounts of cash on hand in order to immediately pay for expenses and new orders of inventory.
Trade credit benefits
One of the great benefits of offering trade credit is the relationship it builds between companies. The buyer is able to receive a brief reprieve and pay for goods at a time that is best for the business, and many times, the supplier company will give a discount if the purchaser pays on a date earlier than the specified deadline – for instance, payment within the first 10 days of a 30 day deadline.
Using an early payment incentive works out well for the supplier company in that they receive payment earlier than expected and that money can more quickly be reinvested back into the business for other purposes. By offering trade credit, supplier sales’ pipelines are also more easily filled as new businesses generally qualify for this payment option and are more likely to do business with companies that offer it. Overall, trade credit helps to drive sales and establishes more cooperative purchasing relationships between businesses.