The advantages and disadvantages of trade credit

Trade credit is a type of short-term financing provided by suppliers to their customers and is often the simplest source of short-term borrowing for many businesses. It’s an arrangement where suppliers allow customers to purchase goods or services on credit, with payment due at a later date.

Trade credit is often used in business-to-business transactions, where one company provides goods or services to another company. The terms of trade credit may include a specific repayment period, interest rates and other conditions agreed by both parties.

It can be an important source of working capital for businesses of all sizes, as it allows them to purchase inventory or supplies without having to pay cash upfront. However, it does come with disadvantages as well as advantages. Below we explore the pros and cons of trade credit as a financing option for businesses.

Advantages of trade credit

Easy to obtain

One of the biggest advantages of trade credit is that it is relatively easy to obtain. Businesses can often obtain trade credit from their suppliers simply by filling out a credit application, and it is widely available in certain industries. Unlike other types of financing, such as bank loans, trade credit does not typically require a lot of paperwork or documentation.

Low or no interest

Trade credit can have lower interest or fees than other forms of credit, or even be interest free. This can be a significant advantage if you are looking to manage your cash flow and keep costs down.

Helps build relationships

By extending trade credit to their customers, suppliers can build stronger business relationships and loyal customers. This can lead to repeat business, as well as referrals to other potential customers. 

As relationships build, trusted partners and bigger clients will often benefit from better terms, or higher credit amounts. 

Improves cash flow

Trade credit can help improve cash flow for businesses, as they can delay payment to their suppliers until a later date. This can help bridge cash flow gaps if you have delays between paying for costs and getting paid.

Flexible payment terms

Trade credit often comes with flexible payment terms, which can be tailored to the needs of the business. This may include longer payment terms or the ability to pay in instalments. Both of these can make it easier for businesses to manage their finances.

Disadvantages of trade credit

Higher cost

Although trade credit can be lower cost than other forms of finance, it can still cost more than paying for the goods or services outright. Paying up front can mean you get a discount, or become a priority customer if there are delays or limited supply. 

Limited availability

Trade credit is only available from suppliers that are willing to extend credit to their customers. This means that you may not be able to obtain trade credit from all your suppliers, which can limit their options in how you manage their cash flow.

Risk of damaging relationships

Trade credit comes with the risk of  customers failing to pay their supplier on time or at all. This can be particularly problematic for small businesses as it can have a significant impact on their cash flow and profitability, and can damage relationships within your supply chain. 

Overdependence

Relying too heavily on trade credit can lead to overdependence on certain suppliers. This can be particularly problematic if a supplier is unable to provide credit, as it can leave the business unable to buy the goods or services they need. It can make it harder to switch to other suppliers too, as it means building the relationship again from scratch.

Might damage your credit rating

Failing to pay suppliers on time can damage your business’s credit rating, which can make it harder for you to obtain financing in the future. This can be particularly problematic for businesses that are looking to grow and expand.

How Funding Circle can help

A FlexiPay line of credit can complement or replace any trade credit you use at the moment. Available up to £250,000, you can use it to pay suppliers, buy stock, equipment and more. It can help you to:

• Pay upfront or bulk buy to get a discount
• Meet minimum order thresholds
• Negotiate better terms
• Pay on time when an incoming payment is late

To see how it can help you, apply for FlexiPay today with no impact on your credit score.