What is trade credit and why give it?

Trade credit is actually a form of free credit given by your supplier. It is an agreement between seller and buyer where the buyer can pay at a later date without any fee. You might think, why would anybody do this?  The seller will have to wait before he has the money in his pocket. Imagine what he could have done with this money . For instance keep the business going by buying goods and supplies.

This week I want to discuss the reasons why anybody would give free credit and how to minimize the chance of nonpayment.

It is important to build relationships with your clients to ensure the future of the company. By giving them more time to pay, they can buy a larger quantity of goods which will benefit both parties. The reseller can sell more goods in the same period of time and will therefore experience growth. He will buy more goods than previously and therefore the company will grow as well.
By giving the option of paying at a later date, will also form a bond of trust. The clients will appreciate this because you give them a chance to inspect the goods before actually paying for them. Downside is that the goods are shipped but you have not received any money for it.

Before giving any credit, you must ensure that your client has the financial ability to pay. This can be a hard and long process which can be simplified by hiring a third party. There are companies who will  investigate your clients and give you a full analysis and credit report. I strongly recommend to use this service especially when you do business within regions of instability and recessive economy.

My advice is to give minimal credit to new clients until they have proven worthy of your trust. Have people do constantly follow ups on the payments and let sales and finance department work together on a regular basis.

To counter the risk of nonpayment, companies can buy credit insurance to insure they will be payed on time. However this will come at a cost.

Bare in mind that giving more credit will have an effect on the gap between selling goods and receiving money. When the gap is enlarged, you will have to have more liquid cash to cover the bills or borrow money from the bank in the meantime.

The question now is: how much money can I borrow from the bank and how easy is it?