Trade credit, sometimes called trade finance or supplier financing, is an extremely common form of exchange between businesses. Famously, Walmart relies heavily on trade credit. But it isn’t only large corporations that utilize this form of agreement between suppliers and buyers—trade credits are extremely common for small businesses, as well.
In fact, according to the World Trade Organization (WTO), an astounding 80% to 90% of all global trade relies on trade finance.
Therefore, trade credits will likely be involved in some way regarding your small business, and you should understand how this system works.
A trade credit is a business-to-business exchange where one business provides goods on credit to another, i.e. no cash is paid up front. In turn, the recipient of the goods promises to pay for the goods on a predetermined time frame.
Trade credits operate on the same basic idea as running up a tab at a bar or grocery store over time, which was common in years gone by. Importantly, though, a trade credit is a very formalized agreement between businesses, not a business and a customer.
In essence, trade credits are like financing with 0% interest—the buyer’s assets increase without the initial expenditure of capital. Depending on the size of your operation and your suppliers, a trade credit agreement might look a lot like a financing application from a bank, but they are often more informal. Typically, trade credit repayments take the form of invoices.
A trade credit is the loan of goods or services from a supplier business to a buyer business. The buyer agrees to pay for the goods or services at a later date.
Trade credits are essential for businesses across the globe. Even if your business doesn’t have trade credit agreements, some organizations in your supply chain most likely do.
“International supply chain arrangements have globalized trade finance along with production,” the WTO notes. “Sophisticated supply-chain financing operations—including for small- and medium-size companies—have become crucial to trade.”
Trade credits have been hyped as one of the secrets to the success of Walmart, which continues to vie with Amazon for the title of world’s biggest retailer. Many of the products available on the shelves of your local Walmart store are procured without money up front.
“Walmart is no different from other large retailers,” points out financing expert Marco Terry. “Most large retailers are known for paying invoices in 30 to 90 days. Large companies operate this way during the course of their normal business.”
Walmart, which would have no problem getting financing in any form, must see a lot of intrinsic value in trade credits—the corporation uses up to 4 times more in trade credits than any short-term external financing.
Walmart probably sees a lot of benefit in trade credits because trade credits heavily advantage the buyer. This favorable condition exists because trade credits basically function as an interest-free loan. Walmart (or any other retailer chain) can start selling products before it has to pay for them.
Small businesses can take advantage of this, too. If you can work out a trade agreement with a supplier, you can begin making sales before spending money on inventory.
A disadvantage of trade credit is the risk involved—even though you don’t have to pay upfront, your business will still have to pay the supplier at some point. If you don’t have the money when the invoice is due, your company could face a dangerous cash crunch. If you don’t pay, you risk ruining your supplier relationship; not paying off trade credits can also damage your business’ credit score.
If you are on the supplier side of a trade credit, an advantage is that trade credits encourage repeat business. Trade credits allow you to do business with companies that might not have the up-front capital to buy from you before making sales.
If you offer trade credit, you basically become a lender, which involves inherent risks. This is why the supplier is at less of an advantage in a trade credit agreement than a buyer.
Make an educated assessment of the situation before offering trade credits. For example, is it worth waiting 30 days for payment if it means your product is placed on the shelves of a popular retailer?
The different types of trade credits are defined by invoice periods. On your invoice, it will typically say “net,” followed by the number of days when payment is due after the invoice date. The most common trade credit type is “net 30,” meaning repayment is due 30 days after the invoice date.
Trade agreements also occur with 45-day, 60-day, 90-day, and even 120-day payment periods. You should typically expect to repay in 30 to 45 days, though.
Bank credit and trade credit are different ways to understand financing available to your business. Bank credit is the total amount of money a business or individual can borrow from a bank. Bank credit includes credit cards, mortgages, and business lines of credit.
The value of trade credit, on the other hand, is connected to the value of goods or services being offered from a supplier to a buyer. Additionally, trade credit is available from suppliers instead of a bank.
A seller credit, or owner financing, is related to the sale of a business. The seller of a business can opt to sell all or some of a business like a trade credit—the new owner of the business can get started immediately and then repay the credit back over time. For the seller, it can allow you to get an overall better price for your business, but you assume the risk of the buyer defaulting. Seller credits are also common in home sales and function similarly to seller credits in the sale of a business.