What Is Trade Credit?

What Is Trade Credit?

Let me explain trade credit to you directly: it's a business-to-business arrangement where you, as a buyer, can purchase goods or services without paying cash upfront, and instead, you settle the payment with the supplier on a later date. Typically, if you're operating with trade credit, suppliers might give you 30, 60, or 90 days to pay, and they record this through an invoice.

You can think of trade credit as a form of 0% financing that increases your company's assets while pushing the payment for those goods or services into the future, with no interest charged during that repayment period.

Key Takeaways

Here's what you need to know: trade credit is commercial financing that lets a customer buy goods or services and pay later on a scheduled date. It frees up your cash flow and can finance short-term growth for your business. However, it adds complexity to financial accounting, depending on the method you use. Regulators encourage trade credit globally, and it opens doors for new fintech solutions. Keep in mind, suppliers are often at a disadvantage because they've delivered goods without immediate payment.

Understanding Trade Credit

As a buyer, trade credit gives you an advantage. In some situations, you might negotiate longer repayment terms, which amplifies that benefit. Sellers usually have specific criteria you need to meet to qualify for it.

With a B2B trade credit, you can obtain, manufacture, and sell goods before paying for them, creating a revenue stream that covers the costs retroactively. Take Walmart as an example—they're major users of trade credit, paying for inventory after it's sold in stores. This applies to international deals too, and generally, if you're offered trade credit, it improves your cash flow.

The credit period—say, the number of days you have—is set by the supplier and agreed upon by both parties. Trade credit is essential for financing short-term growth and, being interest-free, it encourages sales. Since it disadvantages suppliers, many offer discounts for early payments, like a 2% discount if you pay within 10 days of a 30-day term, often noted as 2/10 net 30.

Trade Credit Accounting

You account for trade credits differently whether you're the seller or buyer, and it varies if you use cash or accrual accounting. Public companies must use accrual accounting, recognizing revenues and expenses when transacted.

Trade credit invoices complicate accrual accounting. If your public company offers it, you book the revenue and expenses at the transaction time, but without immediate cash, you record it as accounts receivable on the balance sheet. Defaults or discounts might require write-offs or write-downs, which are liabilities you expense.

On the buying side, trade credit lets you acquire assets without immediate cash outflow or expense recognition. It acts like a 0% loan on your balance sheet, increasing assets while deferring payments and interest. You recognize the expense only when paying cash or receiving revenue, which significantly frees up your cash flow.

Trade Credit Trends

Trade credit benefits businesses with limited financing options most. In fintech, new point-of-sale financing replaces trade credits, partnering with sellers to offer 0% or low-interest options that reduce risks for suppliers and support buyer growth.

Sellers get new solutions like accounts receivable financing, or invoice factoring, providing capital based on trade credit balances. Internationally, the WTO notes 80% to 90% of world trade relies on trade finance, with innovations like LiquidX's electronic marketplace for trade credit insurance. The 2022 Small Business Credit Survey shows 9% of small businesses use trade credit as their third most popular financing tool.

Related Concepts and Other Considerations

Trade credit impacts business financing and connects to terms like credit rating, trade line, and buyer's credit. Your credit rating assesses creditworthiness based on repayment history; without a good one, you might not get trade credit. Late payments incur penalties that hurt your rating and financing options.

New businesses without credit history often can't access trade credit and must seek alternatives. A trade line is your credit account record reported to agencies, tracked by raters like Standard & Poor’s for large firms. Buyer's credit finances international purchases of capital goods, involving cross-border agencies and large minimum amounts.

Advantages and Disadvantages of Trade Credit

For buyers like you, trade credit offers simple, cost-free financing that improves cash flow by delaying payments until after selling goods. It also builds your business profile and vendor relationships. But if you miss payments, you face high costs like penalties or interest, damaging your credit and supplier ties.

Sellers benefit by strengthening client relationships, fostering loyalty, and boosting sales volumes since buyers purchase more without upfront costs. However, you deal with delayed revenue, which strains tight budgets, and the risk of bad debts from non-paying buyers, leading to write-offs that harm your business.

Common Questions About Trade Credit

The most common terms require payment within 7, 30, 60, 90, or 120 days, with discounts for early payment. Trade credit is commercial financing at 0% cost, allowing purchases with later payment. Types include open accounts (informal invoices), promissory notes (formal agreements), and bills payable (accepted instruments with expiry dates). Pure trade credit isn't expensive for buyers as it's interest-free, but late payments bring fees or interest, making it costly.

The Bottom Line

Trade credit is commercial financing that benefits your operations as an interest-free loan, letting you get goods now and pay later without extra charges. This improves cash flows and avoids traditional financing costs.