Trade Credit Definition
Trade credit (or trade finance) is a form of short-term financing that allows B2B transactions to go ahead without incurring any out-of-pocket expenses. This type of payment agreement allows customers to buy goods or services immediately and pay later.
Whether you have new customers who want to partner with you without expending any working capital or you want to give your existing clients a new way to pay, trade credit provides you with a way to grow your business and improve your offerings without having to impose unworkable payment terms on your customers.
While trade credit is highly convenient for small businesses, this financing system has historically suffered from several serious drawbacks. If you offer trade credit on your own, you run the risk of late payments and outright refusal to pay. Pursuing bad accounts distracts you from the important work of running your business.
Traditional Trade Financing
Traditionally, trade credit has been accomplished by suppliers or producers providing the funds their clients need to spur short-term growth with the purchase of goods or services. Since this type of financing isn’t done through financial institutions, businesses that provide trade credit have routinely exposed themselves to serious risks.
When businesses supply trade financing on their own, they are responsible for establishing the credit history and overall creditworthiness of their customers. They are also responsible for taking payments and ensuring that their customers pay on time. These responsibilities add to the workload of small businesses and impede their growth.
Pros and Cons of Trade Credit
Here are a few examples of the benefits and detractors of using trade credit to grow your business:
- Provides immediate payment options that make business-to-business transactions smoother
- Promotes growth for both you and your clients
- Is generally easy for clients to obtain without having to worry about the lengthy application processes demanded by financial institutions
- Gives clients the freedom and flexibility to pay the full price as goods sell or as they take in the capital
- Helps build client relationships by removing payment hurdles
- It can become very expensive if payments are not made on time
- Going it alone with trade credit requires you to perform credit checks and deal with all the other accounting processes involved in supplying credit to your clients
What Is Trade Credit Insurance?
Trade credit insurance protects businesses from the financial risks associated with providing trade credit. If a client does not pay or goes significantly over their payment due date, trade credit insurance kicks in and pays out a percentage of the bad debt. According to Insurance Business Magazine, one out of 10 invoices become delinquent, and trade credit insurance is designed to absorb the inevitable losses associated with providing net 30 terms or any other form of business credit.
While this type of insurance insulates you against some of the risks of offering trade credit, trade credit insurance doesn’t help you vet the creditworthiness of clients or help you with accounting.
Hot Trade Credit Trends
Trade credit is an incredibly popular financing option all over the world. Economist Vicente Cunat has found that trade financing accounts for approximately 20% of all external finance in countries aside from the United States, and the only type of financing that surpasses business credit is bank credit.
In the years following the 2008 financial crisis, it has become harder for small businesses to attain traditional forms of credit as lenders have become increasingly wary of subprime loans. Therefore, many entrepreneurs have chosen to operate outside of financial institutions altogether, and trade credit represents one arm of the new paradigm of business financing alongside peer-to-peer lending and crowdfunding.
The U.S. Federal Reserve found that 60% of businesses in the United States use trade financing, which means that the U.S. small business economy is highly reliant on this type of credit. If these figures are at all indicative of the rest of the world, the UK could be dramatically streamlined by implementing trade credit utilities that make full use of contemporary digital tools.
While trade credit has been around for a long time, CreditDigital takes this popular form of financing and makes it fit for the digital age. The technology exists to make things easier, and CreditDigital eliminates the waste associated with traditional forms of trade credit and uses innovative techniques to make this kind of financing easy and streamlined. By eliminating the pitfalls of trade credit, CreditDigital is leading the global trend toward making financing easier, safer, and more direct.
What Is Credit Analysis?
Credit analysis is a big part of providing trade credit to clients. To figure out whether you should extend credit to a client, you’ll need to vet their creditworthiness according to a variety of criteria; if you don’t take credit analysis seriously, you could get burned.
If you want to take care of the credit analysis process by yourself, you’ll need to ask for several pieces of information from your clients. For instance, you should ask potential trade credit partners for copies of their financial statements. If you notice any discrepancies or worrying trends in these statements, you should deny credit to that client.
Next, you’ll need to obtain credit reports on the client’s credit history with other businesses. If your client has a history of paying back debts quickly and without any problems, giving them trade financing should be a walk in the park. If they have a habit of making late payments, however, you have reasonable grounds to deny that client credit.
Lastly, remember to always evaluate clients based on the Five C’s of Credit:
If you have an existing relationship with a customer, it’s easy to determine his or her character. Determining whether a client is trustworthy and credible is incredibly important before you extend credit, and you’ll also need to gauge your client’s overall personality.
2. Capacity (Cash Flow)
Your client will need adequate cash flow to pack back debts. It must be proved that your client’s cash flow is sufficient and sustainable.
If a client has invested a significant amount into his or her business, that client’s trustworthiness increases. If your client has reasonable financial reserves, full repayment of trade financing capital is likely.
You’ll need to assess the role that the trajectory of the client’s industry and political risk play into the likelihood of repayment. If your client is a newspaper publisher in a war-torn country, for instance, the conditions for financing are poor.
Getting collateral from a client is one of the best ways to ensure repayment. Collateral is an asset that your client promises to give you if he or she defaults on financing.
Handling credit analysis on your own can be a hassle. Here at CreditDigital, however, we take care of vetting your potential trade financing partners for you, which frees you up to do what you do best.
Trade Credit Risks
There’s no way around the fact that offering trade credit on your own is inherently risky. Without a proper safety net in place, your good-natured attempts to fuel the growth of your client relationships can go awry for various reasons.
You have so many other concerns in a given day that it’s understandable if you don’t go through the vetting process that’s necessary if you only want to give out trade financing to the right people. It’s natural to be excited at the prospect of making a sale, but this eagerness could influence you to make unsustainable decisions.
The main risk in the arena of trade financing doesn’t come from your decisions; it comes from your clients. Every business has had a client default at least once, and there’s nothing more disappointing than seeing your hard work go to waste. Even if a client has a valid reason for not making a payment, your bottom line is still hurt.
Risks like these have driven many businesses in the UK to give up on the idea of trade financing altogether.
Trade Financing with CreditDigital
When you offer your customers’ trade credit with CreditDigital, you eliminate the risks associated with trade financing and make transactions even easier for your customers. Services like CreditDigital take on all the risks and work associated with trade credit and give you the working capital you need today to keep growing. When you work with CreditDigital, you gain the ability to keep your client relationships strong and growing without having to worry about trade credit insurance, accounting nightmares, or bad debts.
Trade Credit and CreditDigital
CreditDigital is an innovative solution for firms that want the benefits of trade credit without the risk. Our cutting-edge platform provides your clients with flexible payment windows while providing you with the funds you need to keep growing immediately.
When you work with us at CreditDigital, you gain the ability to be flexible with your customers without ever having to worry about late payments or bad debt ever again. Our services also eliminate the need for trade credit insurance while providing more comprehensive payment protection than even the best insurance providers can offer.
CreditDigital puts an end to the headaches associated with trade credit. When you choose CreditDigital as your business credit solution, you’re investing in your ability to focus on what’s important in your day-to-day business operations without being distracted by pursuing bad debts or any of the other irritating aspects of offering trade credit in-house.
Since we take care of evaluating the creditworthiness of your customers, you won’t have to expend resources on credit analysis. When you extend credit to your customers, accounts receivables tend to pile up, and each invoice has a different number of days until it’s due, which can make accounting overwhelming. With CreditDigital, on the other hand, you receive payment immediately, and you’re freed from the waiting game once and for all.
Your customers will love the flexibility of our payment terms. While it’s often hard for businesses to offer terms longer than net 30 or net 60, we can offer your clients up to 12 months to make payment in full.
CreditDigital makes giving you clients credit easier in every way. When you let us handle the dirty work, you can experience all the benefits of rapid growth and relaxed client relationships that trade credit provides without putting your bottom line at risk.
Related Trends and Concepts
Trade credit is an underlying component of many business transactions, and as a result, it is associated with a wide variety of other business terms. For instance, a client’s credit rating is a summation of his or her creditworthiness. You can rely on credit ratings to make snap judgements about a client’s credit viability without having to do a lot of vetting.
A client’s trade line is the report of credit activity that is given to credit reporting agencies. These agencies then use this information to generate credit scores.
Buyer’s credit is a type of trade credit that occurs at the international level. It is a type of credit that is given to importers that helps them bring in goods from overseas. Buyer’s credit is much more complicated than trade credit, and it usually requires the involvement of the regulatory agencies of multiple countries and exchanged sums in the millions of pounds.