Trade Credit - Financing Your Business

All businesses, large, small or just getting started, have capital needs - to purchase inventory, supplies or whatever materials are needed to provide the goods and services that the business produces and gets paid for.

But, not all businesses have access to that needed capital - either because of some limitation of the business or due to limitations in the market (banks just not lending).

However, many businesses may be able to turn to those same companies that they purchase those materials (inventory, raw materials, supplies) from to get what they need to run and grow their operations - termed Trade Credit.

Overview: Trade Credit:

First, know that with a trade credit arrangement, your business will not receive capital (money, cash) per say but would be able to obtain the materials they need now but only have to pay for them later.

Your suppliers want your business. Without your business and others like you they would have to shut down. Further, these businesses also understand that many of their customers don't have large amounts of cash flow to purchase their goods and services which puts them in a huge quandary - they want to sell you their goods but you don't have the funds to purchase them.

In steps trade credit: In these arrangements, your supplier will sell you their goods and services but instead of requiring payment at the time of the sale, they may give you 10 days, 30 day, 60 days or more to pay for those purchases.

Why? Because it then gives your business the opportunity to take those purchases, run them through your operating cycle (be it to add value to produce a new product or use them in providing a service to your customers).

Then, when you get paid from your customers - you can then pay your suppliers.

In the end, everyone wins - you are able to purchase materials or services that you did not have the capital to do so and your suppliers keeps you as a long-term (and eventually paying) customer.

Bottom line: Trade credit is where your suppliers essential provide you the credit to purchase their goods and services.

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How It Works:

Trade credit is just like any other type of business loan or business credit facility:

Your creditor (your supplier in this case) will want to make sure that you are a strong credit risk or that you are credit worthy.

To that note, your supplier will want to qualify both you and your business. To do this they may do the following:

• Pull your business credit: They will look at how your business has dealt with other suppliers and vendors. Has your business paid them back in the past? Has your business been late? And, is your business willing to repay those who have helped it?
• Pull your personal credit: Again, they want to ensure that you (not just your business) is willing to and has demonstrated in the past that you will repay your suppliers.
• Pull your financial's: Many suppliers will look at analyze your financial strengths via your supplied financial statements or your tax returns. The reasoning here is to see if your business is growing or declining. These suppliers only want to deal with growing businesses - businesses that have the ability to pay for those purchases and businesses that will be long-term customers and not out of business in a few months.
• For most start up businesses, many suppliers will want to view your business plan to see if your new business has the potential to be a long-term, viable entity.

Example: You need 100 iron rods that your business will use to fashion into outdoor deck chairs. Each rod costs $100 from your local supplier. However, you do not have the capital ($10,000) on hand to purchase these rods - but you have retail customers clamoring for your chairs for the up coming summer season.

You approach your supplier who agrees to provide your business those rods - at $120 each - but will allow your business 60 days to pay.

You take those rods (not all suppliers will charge a higher price - but many will - they are taking a risk after all), produce your chairs and sell them to your suppliers.

You collect from your customers and pay back your supplier.

At this point, everyone wins!

Additionally, your suppliers could attach discount terms to your purchases. For example, let say your supplier gives you 'net' 60 days to pay - meaning that you have 60 days to pay in full for those goods. However, they also state that if you pay in full within 30 days - they will reduce your overall price of those goods by 10% and if you pay in full within 20 days, they will offer a discount of 20% of the total purchase amount.

This helps your supplier by receiving payment faster if you are able to pay quicker (they also want to better manage their cash flow by getting payment - actual cash - as soon as possible as well as provides your business with payment flexibility - should you have a stronger period of sales than predicted, you could take the early payment discounts reducing your overall costs and expenses.

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Benefits:

Purchase material, supplies, raw goods or services that you might not have the capital to purchase

Even if you have the cash to purchase needed materials, using trade credit can keep that cash in your business for other pressing needs like payroll, marketing, or other expenses.

The ability of your business to pay for the supplies you need in your business. Instead of paying up front, your business can acquire goods and services, add value to them and resell them to customers - then using those funds to pay for the original goods and services (this is how business is always suppose to operate).

Not a business loan or other financing method - thus no hassle of a business loan like paying monthly payments with huge interest or giving away equity in your firm.

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What You Need To Qualify:

The main qualification for any trade credit is your ability to pay for the materials purchased. Your business has to convince the supplier that not only will you pay but that you will be their long-term customer.

So, make sure your business is aligned with your supplier's goals.

Know that these suppliers really do not care about your operations per say but about the long-term benefits you can provide them by simply being a good customer. If they feel this is the case, they will provide you trade credit - creating a win-win situation.

Also, understand that many suppliers may not initially provide you this trade credit. But, if you purchase material or services from them through several cycles, they may start to warm up to you.

Each time you purchase, ask them to extend your business credit (start small like 10 days). In time, they will break down as you continue to show the long-term viability of your business.

Once approved, make sure you keep extending the terms as long as you can (it is just a financially sound decision on your part to delay payment as long as you can).

At a minimum, make sure you keep working the terms until they (at the least) meet your operating cycle. Thus, if it takes 30 days for your business to purchase goods, provide your product or service then collect from your customers, then you should try to match your trade credit terms to that same 30 day period.

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