Raising finances for a business can be an uphill task, especially when purchasing the supplies for resale or internal use or use in manufacturing. Trade credits come in handy as one of the best and most vital short-term finances for the business.
It involves buying goods or services without making an immediate payment, with some agreed-upon credit sales terms. These terms refer to the timeframes and discounts allowed to the buyer after they are billed for the goods or services they have received.
Companies often do not ask for immediate payment except when dealing with new businesses (customers) whose creditworthiness is still unknown to them.
The best thing with trade credits and discounts as a form of finance is that they offer one solution to two problems:
They help businesses to cope with cash flow issues and at the same time help to build a credit history that they can use with lenders or other creditors to get other forms of finance.
How to Use Trade Credits and Discounts
The seller/supplier usually comes up with the credit terms, but they may be negotiated with the buyers.
The terms include the total outstanding amount for the goods or services and the buyer’s duration to pay the amount.
Also, they will most likely include a discount or bonus for early payment and some penalty for late payment.
For example, credit terms may be “2%/10 days net 30,” which means the buyer gets a discount of 2% if they pay within ten days or settle the full amount before the end of 30 days. However, failure to pay in 30 days will amount to delinquency and attract a late payment penalty.
Other credit terms may give the option of several equal payments. For example, a bill payable in three equal amounts after 15 days would signify paying the first third in the first 15 days, the second third after 30 days, and the final third by the 45th day.
Consequences of defaulting payments
What if the buyer misses paying their payments on their due dates? Well, as mentioned earlier, the seller may charge the buyer a late payment fee, which may be a certain percentage of the sum of the bill.
Additionally, the seller may hand over the overdue accounts to a credit reporting agency. The effect of this is that if you are the involved customer, it will hurt your credit score, and you will have problems accessing credit purchases or loans in the future.
Therefore, buyers must avoid such occurrences by making timely payments or communicating with their creditors in case of any difficulties.
Those already facing credit score problems should consider engaging Boostcredit101 to help them improve their rating using trade lines and give them crucial advice on rebuilding their scores.
The advantage of trade credit and discounts as a financing option
With several payment and discount options available, a company with excess cash can negotiate for a higher early payment discount, of about 3% or 4%, and in return reduce the payment days from 10 to 5, for example.
In such a case, cash flow utilization is optimized as the business pays less for its purchases. On the other hand, a business with cash flow problems can negotiate for a longer payment period, like 60 days or more, if possible.
The equal payments option would be a good idea for a business that owes its suppliers high amounts and wants to reduce it but does not have surplus cash flow.
Trade credits and discounts are great ways to improve its financing at minimal costs and build its credit history. It can additionally help to optimize surplus cash flows by getting high discounts for earlier payments.
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