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How to Use Short-Term Financing to Purchase via Trade Credit

Trade credit can be a relatively easy, effective, and low-cost way to secure small business financing, even for startups and new businesses. However, trade credit is an unfamiliar concept for most entrepreneurs.

Here, we break down what you need to know about trade credit to determine if it’s the right financing option for your business.

In this article:

• What trade credit is and how to purchase and use it
• How trade credit can finance short term business loans
• The benefits and hidden costs of trade finance

What is trade credit?

Trade credit, often referred to as vendor credit, is a form of short-term financing from suppliers and service providers that does not require the traditional financial institution application process for short-term business loans.

These short-term business finance arrangements function as credit, letting your company buy now and pay for goods or services at a later date. In short, any time your business accepts delivery of goods, supplies, or services without making an immediate payment, it’s leveraging trade credit.

Depending on the vendor, trade credit interest costs may be very low. For vendors, trade credit is an incentive to attract new customers and promote customer loyalty. Trade finance is a perk of doing business with them. Since some vendors also report to credit bureaus, trade credit may help your applications for short-term business loans in the future.

How trade credit works

Trade credit can take many forms, depending on when you agree to pay a vendor for the goods or services they supply. The different timings are referred to as trade credit terms.

The most common type of trade credit is net-30. Net-30 terms mean you must pay in full for products or services within 30 days of receipt of the invoice.

In addition to Net-30, other trade credit terms include:

• Net-15: Payment is due within 15 days of the invoice date.
• Net-45: Payment is due within 45 days of the invoice date.
• Net-60: Payment is due within 60 days of the invoice date.
• Net-90: Payment is due within 90 days of the invoice date.
• Net-120: Payment is due within 120 days of the invoice date.

Hidden costs of trade credit

Some vendors may not charge interest on trade finance agreements. If they do, it’s a minimal amount. However, don’t conclude that trade credit is always free or extremely low-cost financing. There are often hidden costs associated with this type of short-term credit.

For instance, many vendors offer their customers a cash discount (also called a trade discount) for paying cash on delivery of goods or services. When you leverage trade credit, you may not be eligible for those cash discounts anymore. In this case, using trade credit costs you by missing out on the benefit of an early payment discount.

Additionally, late payments on vendor accounts can add up quickly. Late penalty payments vary between suppliers but can sometimes rise to 15% or more. Always check invoices and contracts to see if they include late payment penalties. If you’re not sure, contact the vendor. Even if late fees are minimal, it’s always a good idea to pay your bills on time.

Frustrated vendors might report your account to commercial credit bureaus, which could harm your business credit score.

How to use trade credit

Trade credit is used by many businesses that purchase all types of goods, supplies, and services. Business-to-business (B2B) companies in many industries offer trade credit. You may get essential items and services for your business by leveraging payment terms through trade financing. It’s a popular type of financing because it provides greater liquidity to businesses with low or no additional cost.

Some common uses of trade credit include:

• Getting business financing: Trade credit offers businesses some additional financial flexibility, which may make their financial picture look better on a short-term business loan
• Increasing cash flow: By delaying payments, businesses can get a temporary increase of cash flow to cover unexpected expenses or increased costs without taking on the debt of business cash flow loans.
• Improving credit score: Businesses that are seen as a credit risk can use trade credit to build up a business credit score and make themselves more appealing to lenders in the future.

If you work with vendors that report to a commercial credit bureau, trade credit can be a powerful tool for building business credit. That’s very useful for new businesses that may look for funding in the future. Every time you make an early or on-time payment with a vendor on your trade credit account, you’ll improve your creditworthiness, which can help you get approved for small business loans, a business line of credit, business credit cards, working capital loans, and more.

Pros and cons of trade credit

Like any business financing, there are benefits of trade credit as well as drawbacks. Borrowers should be aware of these pros and cons:

Pros

• Cash flow management: Trade credit allows you to purchase the goods and services your company needs and delay payment. They’re an excellent way to gain control over cash flow and your accounts receivable and payable.
• Build credit: Trade credit can help you build a business credit history, allowing you to possibly qualify for short-term business loans and other financing in the future.
• Good for new businesses: Some vendors approve trade credit for new businesses, often the first form of financing for entrepreneurs and startups. This is useful because many traditional lenders have time in business or profitability requirements for short-term business loans and other business finance options.
• Lower credit requirements: Certain vendors don’t check personal credit scores before approving trade credit applications, making them a possible financing option for business owners with bad credit.
• Low or no interest: Many vendors don’t charge interest on trade credit financing, making it an attractive option.

Cons

• Loss of perks: You could lose out on trade discounts if you take advantage of trade credit, which could harm your business's bottom line.
• Potentially no credit impact: Not all vendors report your account history to a commercial credit bureau, so if you’re using trade credit to build up your business credit, working with these vendors won’t help.
• Potentially harmful to business credit: Using trade accounts could harm your business credit if you don’t pay on time. If you fall behind on payments, the negative impact on your business credit score could be severe.
• Fees: You could be charged costly late fees or incur other penalties if you don’t pay your bills on time.

What to do before applying for trade credit

Running a successful business for several years improves your chances of getting approved for short-term business loans. It will also help you secure higher credit limits, lower interest rates, and better credit terms.

Trade credit is typically easier to qualify for than other types of business financing. Still, vendors are concerned about risk. They don’t want to provide credit terms to operations that won’t be able to pay for the goods and services they deliver. They want to avoid bad debt at any cost.

Here are a few things you can do to increase the likelihood of your business being approved for trade credit.

• Get an Employer Identification Number (EIN) from the IRS. This is a unique business tax identification number. You typically need an EIN to apply for vendor credit and small business loans. If you don’t have one, it’s imperative that you get one.
• Open a business bank account and business credit card. Separating business and personal finances makes accounting and tax preparation simpler. It also makes your company seem more credible when you apply for business financing.
• Create a Google Business Profile. Being present on Google is another way to legitimize your business to lenders and suppliers.
• Register with Dun & Bradstreet for a D-U-N-S number. This is a critical step in establishing business credit with Dun & Bradstreet and qualifying for the credit bureau's PAYDEX Score (business credit score).

Remember to monitor your business credit regularly. Vendors and lenders typically check your business credit rating when you apply for financing. Mistakes often appear on credit reports that could hurt your chances of being approved for business financing. Better to find them before applying for loans.

Final Thoughts

Trade credit can potentially help you improve cash flow, gain control over your balance sheet, and build business credit without the debt and interest rates of a loan.

That said, trade credit could even improve your financial situation enough to apply for a short-term business loan to spur growth or expansion.

Regardless of how you plan to use trade credit, it’s crucial to make on-time payments to avoid late fees or negative impacts to your credit score.

FAQs about trade credit

What is trade credit?

Trade credit is a type of short-term financing from suppliers and service providers. In this arrangement, a vendor delivers the goods and services you need from them and allows a delay in payment.

What are the advantages of trade credit?

Trade credit has several key benefits for small businesses. It may help you increase cash flow to meet other expenses and potentially build your business credit score. Moreover, trade credit may give your business additional financial flexibility to apply and pay for short-term business loans to fund growth and expansion.

What are the drawbacks of trade credit?

Depending on the vendor, you may face stiff penalties for late payments and forfeit benefits like cash discounts when you’re using trade credit.

Can you use trade credit to get short-term business loans?

While trade credit isn’t a loan, exactly, it can improve your business’s cash flow, financial stability, and credit score. All of these are important factors that lenders weigh when you apply for a loan.

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