How To Apply For Trade Credit

Trade credit is any arrangement in which a business can buy goods or services now and pay for them later at a mutually agreed-upon date—typically 30, 45, 60, or 90 days in the future. Also sometimes called placing an order on account, this credit relationship between vendor and business is an excellent way for small businesses to order inventory or raw materials for resale without having to outlay the cost of the goods immediately.

If your business routinely places bulk orders with an outside vendor for raw materials, stock inventory, small equipment, or even office supplies, the best place to find funding for those purchases may actually be from the vendors themselves.

Understanding Invoicing Terms With Trade Credit

Although trade credit is a form of debt financing, the agreement between vendor and business in a trade credit arrangement is typically less formal than a bank, credit card issuer or lender. However, some vendors do require credit checks for new busienss accounts, but most do not—and often, the invoice itself is the only indication of a credit relationship.

When you negotiate a trade credit arrangement with a vendor, the terms of that relationship should be indicated on your order invoice. This includes the due date of payment, along with any late penalties or discounts for prompt payment. Since your invoice is effectively a loan agreement between supplier and business, let's quickly review some common invoicing terms you may encounter.

Cash-based invoicing: Anytime a vendor expects payment for an order before or at the time a product is delivered or service is performed, that is an example of cash-based invoicing. Here are some common terms you might see on a vendor's website, in a contract, or printed on the invoice indicating that they traditionally operate on a cash-based invoicing system:

• Paid in advance: Payment must be submitted before the order will be shipped.

• Cash on delivery: Payment is due in cash at the time that the order is delivered.

• Due on receipt: Payment is due immediately upon receipt of invoice.

In each of these cases, payment for an order is due either before the order can be shipped or immediately after the order is delivered. Along with companies that issue invoices with these terms, any vendor from whom you purchase items in a point-of-sale fashion—either with cash or on a business credit card—is also effectively using cash-based invoicing.

Trade credit invoicing: Invoices issued on trade credit are typically issued as “net” followed by the number of days from issue that trade credit is extended. This is based on days from date of invoice, and both the invoice date and the payment due date are listed on the invoice. For example, you might see one of the following terms on an invoice with trade credit.

• Net 30: Payment due within 30 days of invoice date.

• Net 45: Payment due within 45 days of invoice date.

• Net 60: Payment due within 60 days of invoice date.

Many vendors default to net 30 invoicing terms, meaning you do not even have to negotiate for trade credit. Even so, it's a good idea to ask about any new vendor’s standard invoicing terms before placing your first order so that you can discuss a trade credit agreement if needed.

The Cost of Trade Credit

Most trade credit agreements are not interest-bearing in the traditional sense, but that does not mean that purchasing goods or services on trade credit comes without cost. If you pay attention to your vendor’s invoice terms, you will find the saying holds true that “there's no such thing as a free lunch.”

Let's take a look at the two most common methods that vendors use to protect their cash flow when extending trade credit to business’. From your perspective as a potential business, these are costs of doing business on trade credit—not unlike the cost of interest on a loan.

Cash or Prompt Payment Discounts
To improve cash flow and shore up their own cash on hand, vendors that routinely issue net 30 or net 45 invoices on trade credit sometimes include in their terms a percentage discount for cash on delivery or prompt payment of invoices. This could include terms such as a 5% discount on invoices paid within 10 days of issue, for example.
It sounds like a dream scenario, right?

Your vendor is willing not only to extend trade credit on the order you placed but is even discounting your order if you can pay earlier than requested! But let’s stop and think about this for a minute, because the term discount in this context is a bit deceiving.

Remember, the vendor is the one setting the prices on their merchandise in the first place. They chose that price that they’re discounting from, most likely by determining a cash price, then increasing that price by the amount of their posted prompt payment discount to set a net 30, 45, or 60 day price. In reality, the “prompt payment discount” or cash price is the real price of the goods, and the amount of the discount is actually your cost of using trade credit.

Late Payment Penalties
A single cash flow scare caused by late-paying business’ is usually all it takes for vendors to wise up to the importance of including late payment penalties in their invoicing terms. In fact, some accounting professionals would suggest that if your invoice doesn’t include a late payment penalty, it doesn’t really have a due date! As a result, it is not at all uncommon to see invoices from vendors that include a 10% or even 15% penalty charged on all overdue invoices.

Of course, it goes without saying that you want to avoid late payments at all cost—not only because of the hefty penalty or the fact that paying late might damage your relationship with your vendor—but depending on the vendor’s credit reporting policies, a history of late payments could make its way to your business credit report and jeopardize future financing opportunities for your business.

If ever you find yourself in a position where you might be forced to pay a vendor after the invoice due date, always contact the vendor in advance to explain the situation. Suppliers are far more likely to show understanding if you let them know what’s going on and offer a solution.

On the flip side, if you have stellar payment behavior, see if your supplier will report to the business credit bureaus—it may help improve your business credit scores. Not all vendors will do this, but popular suppliers like Uline, Quill, and Grainger do report to business credit bureaus.