What is trade credit in business? 

Trade credit, also known as supplier credit, is an arrangement between two businesses in which one business (the supplier) allows the other business (the buyer or customer) to purchase goods or services on credit terms, allowing the buyer to pay at a later date.

Trade credit also involves credit terms, this refers to the specific conditions and arrangements agreed upon between a supplier (vendor) and a buyer (customer) regarding the extension of credit for the purchase of goods or services. These terms outline the conditions under which the buyer can make purchases on credit and when and how the payments should be made. 

Credit terms will include a credit period, which specifies the length of time during which the buyer can use the purchased goods or services before payment is due. For example, "net 30" means the buyer has 30 days to make the payment from the date of invoice.

Credit terms will also include any conditions such as a discount to the buyer for early repayment, or late payment fees.

How does trade credit work? 

Trade credit works by a supplier releasing goods or services to the buyer. The buyer then pays for the goods at a later agreed upon date. 

Here’s a breakdown of how trade credit works: 

  1. Order: Buyer places an order with a supplier.
  2. Credit Terms: They agree on payment terms (e.g., 30, 60, or 90 days).
  3. Delivery: Supplier delivers goods or services.
  4. Invoice: Supplier sends an invoice with payment details.
  5. Payment: Buyer pays within the agreed period.
  6. Late Payment: Penalties may apply for late payment.
How trade credit works infographic

What affects trade credit? 

A variety of factors can impact the amount of trade credit and the terms that your business could access. For example, the industry of a business can affect the credit terms. While e-commerce or merchant businesses may have shorter trade credit terms, manufacturing businesses may be able to access longer credit terms. This is due to the typical length of the customer cycle for the business. 

The amount of trade credit a business can access will also depend on the strength of their business credit score. If you have a good business credit score, this will demonstrate to the supplier that you are creditworthy and likely to repay on time, so they may be more likely to offer you trade credit and potentially extended payment terms. 

Your business credit profile will also include a suggested credit limit as an amount in pounds (£). Your credit limit is the maximum amount the credit bureau recommends your supplier should extend to you. The higher your credit limit is, the more trade credit you will be able to access with each of your suppliers. 

Trade credit advantages and disadvantages

Advantages of trade credit

  • Trade credit improves cash flow for the buyer, allowing them to obtain goods or services without immediate payment.
  • With improved cash flow, the business will have more working capital available to invest in other areas of the business.
  • Access to trade credit enables businesses to take on larger orders to grow. 
  • Trade credit acts as a free form of borrowing as there is 0% interest charged.

Disadvantages of trade credit

  • If you do not pay on time or comply with the agreed upon terms, this could damage your relationship with the supplier or customer. 
  • Trade credit isn't suitable for all types of business, for example it will not be useful for a business that does not work with suppliers. 
  • Trade credit isn’t suitable for all business needs. As you’re not accessing more funds, but speeding up your cash flow cycle, it won’t be suitable if you need an injection of new capital.

Can I access more trade credit?

The amount of trade credit you can access largely depends on your business credit score and recommended credit limit. 
Our Credit Review Service provides you with the ability to have your Experian business credit score reviewed and in 96% of cases this results in an improvement.
With an improved credit limit, this means you could access more trade credit with every single one of your suppliers. 

How to manage trade credit 

While trade credit offers numerous advantages, it's essential to manage it responsibly to avoid financial pitfalls. Use the following tips to manage your trade credit: 

  • Keep track of credit terms and payment due dates to avoid late payments, which can damage your relationship with suppliers.
  • Negotiate credit terms that align with your cash flow and business needs. This may involve extending payment terms or requesting early payment discounts. If you have an improved business credit score, you will be in a stronger position to negotiate more favourable terms. 
  • Evaluate the financial stability of your suppliers to ensure they can meet their obligations. You can do this by running company credit checks on your suppliers, this will allow you to identify any risks early on. You could also consider diversifying your supplier base to reduce risk.
  • Maintain detailed records of all trade credit transactions for auditing and reporting purposes.

What types of businesses can use trade credit?

Trade credit is commonly used by businesses in the construction sector. For example, a painter, decorator, or carpenter business may access trade credit from Screwfix or Travis Perkins, to access the materials they need to complete a job without the upfront costs. 

However, trade credit could be beneficial for businesses in any sector. If you work in the retail sector, you could use trade credit to purchase new stock to meet high demand. Alternatively, if you operate in the manufacturing industry, trade credit could be extended to wholesalers and distributors for bulk purchases, facilitating distribution and sales.

Frequently asked questions about Trade Finance

There are a number of alternatives to trade credit, such as invoice finance, a merchant cash advance, or a traditional business loan. These options provide various ways to secure finance, manage working capital, and meet specific financial needs for a business. The choice among these alternatives depends on the business's unique circumstances, their creditworthiness, and objectives. At Capitalise, we work with 100+ lenders offering a variety of options for your business. You can speak to a funding specialist to determine what could work best for your specific needs. 

Yes, there are risks associated with trade credit, such as late payment penalties, strained supplier relationships, and potential damage to a business's creditworthiness if payment obligations are not met.

If a business faces difficulty paying trade credit invoices, it is important to communicate with the supplier as early as possible to discuss payment options or request extensions. Open and transparent communication can help avoid strained relationships.

Yes, trade credit can be used for the purchase of both goods and services, depending on the agreement between the buyer and supplier.

No, trade credit and business loans are different. Trade credit is a form of credit provided by suppliers to buyers for the purchase of goods and services, while a business loan is a lump sum of money borrowed from a lender for various business needs, which will be repaid with interest. 

Trade credit insurance is a tool used by businesses to safeguard against the risk of customer non-payment. With trade credit insurance, a business purchases a policy from an insurance company that covers a portion of its outstanding receivables against non-payment due to factors such as customer insolvency or default. The insurance company assesses customer creditworthiness and provides recommendations, and in the event of a covered default, the insured business can file a claim for reimbursement.