Trade Credit: What Small Business Owners Should Know

How trade credit works

A supplier ships goods and sends an invoice with payment terms. You pay within that window instead of at delivery, which gives you free short-term use of the supplier's money.

Say a restaurant orders $8,000 of food and supplies on net-30 terms. The goods arrive today. The invoice is due in 30 days. In the meantime the restaurant sells the food and collects revenue, then pays the supplier from those sales. No loan application, no interest, no new account at a bank.

Behind the scenes the supplier is extending an unsecured loan. That is why suppliers check your payment history and, for new accounts, may start you on cash-in-advance or low limits. Trade credit sits on your balance sheet as accounts payable, which our guide to accounts payable explains.

Reading common payment terms

Terms such as net 30 mean payment is due in 30 days. Terms such as 2/10 net 30 offer a discount for paying early. The shorthand tells you the true price of waiting.

Learn these abbreviations:

• Net 30, net 60. The full invoice is due in that many days.
• 2/10 net 30. Take a 2 percent discount if you pay within 10 days. Otherwise pay in full by day 30.
• COD. Cash on delivery. No credit extended.
• EOM. Terms start at the end of the month of the invoice, which stretches the real time.

Always confirm when the clock starts: the invoice date, the shipping date or the delivery date. A few days of difference can decide whether you pay on time.

The hidden cost of skipping early-pay discounts

A 2/10 net 30 term costs you a lot if you skip the discount. Passing up 2 percent to wait 20 more days works out to an annual cost well above most loans.

Here is the math. On a $10,000 invoice with 2/10 net 30, paying on day 10 costs $9,800. Paying on day 30 costs $10,000. You pay $200 to hold $9,800 for 20 extra days. That is about 2.04 percent for 20 days, which, repeated across a year of 18 such periods, comes to well over 35 percent annualized.

So if a discount is offered and you have the cash, take it. If you do not have the cash, even a short-term borrowing cost that is lower than the discount can pay for itself. Compare the discount with what a draw on a business line of credit would cost over the same 20 days. This is an illustrative calculation, so run it with your real invoice and rate.

Building trade credit from nothing

Start with smaller orders, pay on time every time, ask suppliers that report to business credit bureaus, and request higher limits after six months or so of clean payment.

New businesses usually start on prepayment. To work up to terms:

1. Place small orders and pay quickly.
2. Provide business references, bank details and your tax ID when asked.
3. Choose suppliers that report your payments to business credit bureaus.
4. Ask for a limit increase after a steady record.
5. Keep a separate business bank account so your payment history is clear.

On-time supplier payments feed your business credit file, which helps with later financing. Our guide to building business credit covers the other pieces.

Risks of leaning too hard on suppliers

Late payments can trigger cutoffs, late fees and damaged relationships. Stretching payables to survive is a warning sign that cash flow needs a fix.

Trade credit is not free if you abuse it. Watch for:

• Late fees and interest written into the terms
• Credit holds that stop shipments when you most need goods
• Weaker negotiating power when a supplier knows you are stretched
• Dependence on a single supplier whose terms can change

A useful habit: track days payable alongside days sales outstanding. If customers take 60 days to pay you and your supplier wants payment in 30, you carry a 30-day gap and must fund it somehow. See cash flow vs. profit for how that gap shows up.

When supplier terms are not enough

If suppliers will not extend credit or your customers pay far slower than you owe, outside working capital can fill the gap, provided the payback math works.

Perhaps a new supplier wants payment up front on a $40,000 order, but your customer will pay in 45 days. Funding can bridge the 45 days. In this illustrative case, if the order earns $14,000 of gross profit and the financing costs $3,000 in total, you keep $11,000 and a customer relationship.

ROI Funder considers 500+ FICO, 6+ months in business and $20,000+ monthly revenue, and starts from payback math, showing true cost and payment size before you sign. Look at working capital or inventory financing, or start an application. It takes a few minutes and uses a soft credit pull.