Trade credit for small businesses

The advantages of trade credit discussed in the earlier section, apply to small and medium sized businesses. In this section of, weíll look at how small businesses can avail trade credit from their suppliers and things these businesses need to watch out for before entering a trade credit arrangement with their suppliers.

Availing trade credit

While it may be easier for established firms to get into trade credit arrangements with their suppliers, a newly established firm may find it difficult to gain trade credit immediately. Trade credit is an arrangement based not only on an evaluation of credit risk of buyers by the suppliers, but also on a relationship of trust between buyers and suppliers. Consequently, new firms will typically find it difficult to enter into trade credit arrangements with suppliers straight away. These firms might have to go through a few buying cycles, during which payments are monitored closely by suppliers, build up a reputation of being prompt payers and create a relationship of mutual trust before entering into a trade credit arrangement.

Some suppliers may also evaluate a firmís financial plans before committing to extend trade credit. If you own a business, make sure you approach the owner (if itís a small company) or the chief financial officer (CFO; if it is big company) or any other authority that approves trade credit requests. Make sure you explain your financial plans accurately, for them to get a clear picture to make a decision.

Things to watch out for

The terms of a trade credit arrangement differ for different suppliers. Make sure you completely understand the terms and conditions before entering into a trade credit agreement. The cost of trade credit is usually a higher purchase price, since as discussed in an earlier section, you forego a certain discount for making immediate payments. Thus, you are purchasing at a higher relative price. Before entering into a trade credit agreement, make sure you understand the impact of this higher purchase price on your business. You would also do well to look at costs associated with late payments, any other penalty charges, conditions under which the purchased goods can be returned back for no cost. Efficient use of trade credit is essential to manage small businesses, so that such businesses incur fewer costs compared to the traditional mode of borrowing from financial institutions.