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As a small business owner, you know your business doesn’t pay for goods and services the same way that consumers do. You’re likely accustomed to trade credit, or perhaps what you know as “net terms” on your invoices. Trade credit is a frequent practice in most B2B commerce, and an expected business standard for many companies. And there’s a good reason for it: Trade credit works.
It’s not enough to just see net terms on your invoices, though. Understanding how trade credit works can help you use the practice to your best advantage. Here are the most important things to know:
Trade credit is a financing agreement. It says that your customer can have your goods or services now but pay you later.
Most often, net terms are 30 days (this is where the term “Net 30” comes from), but depending on your business, it could be as long as 120 days or longer. If the customer is unable to pay the balance of the bill or can’t pay it in full, the balance incurs fees or penalties. This normally takes the form of interest.
Essentially, you act like a bank to your customers, “loaning” them the money to pay their bill to your company. Trade credit is also called vendor credit or net terms.
Roughly 60% of small businesses use some form of trade credit to finance their operations, and around 43% of all B2B transactions are funded this way. Trade credit works for a few reasons.
First, lots of companies have difficulties securing financing. Even if they were able to qualify for a business loan, securing additional financing can be a challenge. Often, the owner’s personal financials are called to question and the paperwork alone can be prohibitive, especially if time is important.
Secondly, the process is straightforward. Your customers get the goods or services they need today, and they have some wiggle room in the repayment without having to go through an intense financing application process.
Finally, trade credit can help your customers delay payment to you until they receive payment from their customers. For example, let’s say you have a computer company and offering net 30 terms. If you sell a local jam maker a printer that does labels, they have 30 days to package and sell that jam before needed to pay your bill.
Net terms have some clear advantages for your customers—often, B2B buyers really rely on those terms. But the practice of trade credit also produces some important benefits for your business itself. Here are four of the main benefits:
When your customers know they can turn to you to get the products or services they need and have time to pay you back, they tend to appreciate it. While some of them will end up owing you money for longer than you might like, most of them will come back again and again.
Many customers will also spend more when they can buy with net terms. This is because the flexibility in repayment makes it easier for them to afford a larger purchase, a more expensive package or product peripherals. For your company, this can mean higher sales.
Offering trade credit is also a competitive advantage. Many companies, especially small businesses, simply don’t have enough available cash flow to offer net terms. Clients don’t want to take out a loan just to buy your products or service. The fact that you offer trade credit could make a business buy from you instead of a competitor.
The ability to offer vendor credit terms proves your company’s financial security as well. Again, it isn’t something every business can do. But if your company can, it’ll help to establish your reputation as a financially secure and responsible.
There are some disadvantages to offering net terms, too.
When you offer trade credit to your customers, your own cash flow becomes undependable. You don’t know exactly when your customers will pay up. You also might incur additional costs when comes to trying to collect on those bills. Your accounting team will have to keep up with the accounts receivable records, track payments, apply interest or penalties, and essentially act as a bank. The combination can put a lot of strain on your finances and your operations.
Some companies offer discounts to those customers who pay their bill in full within a certain time frame (10 days, for example) because otherwise, you could be waiting for weeks before you see a dime, especially if you don’t use any invoice factoring companies.
For some customers, the ability to get a discount is enough to prompt payment, but there are other ways you can take the burden out of offering net terms, like Fundbox Pay. The service lets your company get paid right away and still let your buyers take advantage of net terms as long as 60 days.
Offering trade credit or net terms means that your customers have a set number days to pay their bill to you in full. The practice is really common in B2B businesses because it can create customer loyalty by making it easy for your customers to fund their purchases. Net terms also act as a competitive advantage, helping you increase sales volume and prove financial security.
The downside is that offering trade credit can strain your cash flow. But offering discounts for early payment or using one of the newer third party payment services can help you get paid faster and offer a win-win for you and your customers.