Know the Pitfalls of Trade Credit

Disadvantages of trade credit for you as a supplier

The bad news for suppliers is they tend to carry a larger part of the risk in the trade credit advantages and disadvantages equation. While there are lots of routes open to deal with problem buyers and getting back money your business is owned, these can be time-consuming and costly – potentially impacting your cash flow and causing financial problems.

Late Payments – Buyers paying late is the major problem suppliers face when offering trade credit. Depending on your industry, be prepared that most buyers will sometimes pay late. According to Creditsafe, more invoices are paid late than on time.

Cash flow problems – Late payments or buyers simply not paying at all can lead to serious cash flow problems for suppliers. With the need to pay their own outstanding bills, suppliers can be effectively caught between demands from creditors for payment and chasing after buyers for overdue cash. Ensure your business has a strong cash reserve and doesn’t overextend on credit. Offering discounts to buyers who make early repayments can also help alleviate cash flow problems caused by late payers.

Bad debt – Late payments are one thing, but non-payment can present a serious challenge. Customers using trade credit may go out of business or payment may simply be too difficult to chase down, which means your business will need to write off the loss as a bad debt. It’s worth investigating trade credit insurance, which can insure your business for bad debt caused by defaults on trade credit agreements.

Customer assessment – Offering trade credit is an act of trust. Assessing whether a customer has the means to repay you is worth doing right, but determining a buyer’s credit worthiness can be time-consuming. You’ll need to check references, obtain credit reports and review trading history – all of which takes time. Escrow takes this worry out.

Account handling – Offering trade credit involves a lot of paperwork and administration. As a supplier, you’ll need to get professional legal help to write terms and conditions, and you’ll need dedicated account handlers to ensure that outstanding invoices are chased up. Setting clear invoice terms and ensuring good communication can help encourage buyers to pay promptly and regularly. Investigate online accounts software with CRM and invoicing – they often include free alerts when invoices are due.

Disadvantages of trade credit for your as a buyer

While there are many upsides to trade credit, there are still potential drawbacks that are worth understanding. Access to free credit can seem a lifeline for a cash-strapped business but if the fundamentals of your business mean you’re likely to miss repayments, you might want to think again about relying on trade credit.

Hard to obtain for startups – Trade credit seems perfect for startups. Access to stock without upfront payment could help get your business up-and-running. However, trade credit is significantly harder for new businesses to obtain or it may be offered on restrictive repayment terms. Until your business has established itself and built up a consistent trading history, some suppliers will be reluctant to offer your business trade credit. And the bigger the risk the poorer the terms, making it more expensive for startups.

Penalties and Interests – While trade credit is effectively ‘free money’ and can be repaid without interest, missing repayment deadlines can turn ‘free money’ into ‘expensive debt’. Most trade credit terms and conditions include penalties for late payments and interest payable on outstanding credit. This can quickly spiral into significant costs if your business doesn’t work to clear trade credit debts.

Legal action – Fall behind on trade credit payments and your business could face legal action, including goods and assets being seized to pay outstanding bills.

Negative impact on credit rating – Prompt repayments of credit is good for your business’s credit rating; missed deadlines and late payments can quickly harm your rating. That can have an impact when your business later seeks to raise finance such as obtaining a small business loan, as a poor credit rating can affect the amount of interest you’ll have to pay or even if you can secure a loan in the first place.

Loss of suppliers – When faced with a poor-paying buyer, suppliers may be tempted to cut their losses and refuse to work with your business. Suppliers can pull the plug on working with you, leaving your business unable to operate or meet customer demand – potentially resulting in the closure of your business.

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