Trade credit – what is it and what are the benefits for entrepreneurs?

As you can see, there are many more of them than those offered by banks or loan companies. One of them is trade credit. What exactly is it about? Let’s take a look at the benefits it provides.

Trade credit can only be granted by an entrepreneur to another entrepreneur. It is therefore a form of financing between companies. Importantly, it does not involve banks or, even less, loan companies. Check how it is done.

What is trade credit?

The definition of trade credit is quite simple. Trade credit, also known as trade or commodity credit, is granted by the seller to the buyer and has the form of a deferred payment date. It is therefore a non-bank form of financing business activity.

Trade credit is most often used by small and medium-sized enterprises, including self-employed persons. In some cases, trade credit is an advance payment for a good or service that has not yet been performed.

Who can grant a trade credit?

In legal terms, trade credit is a special type of credit. Its subjects are economic entities that are not financing institutions. A normal sale and purchase transaction becomes a trade credit when the parties to the transaction agree to postpone the moment of payment.

The number of days between the release of the goods or the performance of the service and the scheduled payment date is called the credit period. Who, therefore, grants a trade credit It can only be done by an entrepreneur concluding a transaction with another entrepreneur.

Who can get a trade credit?

Trade credit may be granted to an entrepreneur who is the recipient of a good or service. He then receives the option of deferring the payment from the other entrepreneur (supplier of goods or services). Thanks to this, it is possible in his case, among others maintaining financial liquidity. 

Conditions for obtaining a trade credit

Detailed terms of the trade credit are agreed upon between the supplier and the recipient of the goods or services. There is no denying that this form of payment relies on trust between the parties. Usually, long-term partners can benefit from it.

Trade credit is therefore not granted to new contractors. The most common deferral period is 30 days. T about whether trade credit bears interest also depends on the parties to the agreement.

What is the cost of trade credit?

The cost of the trade credit comes down to the loss of the discount that the customer would probably have received with immediate payment. What about the interest rate on the trade credit?

What distinguishes it from a bank loan is the lack of interest. The entrepreneur usually does not charge a commission for its provision or any additional fees. 

Trade credit and payment terms

The parties to the contract, i.e. most often the seller and the recipient of the goods or services, agree on the date of payment of the trade credit. It usually depends on the specifics of the industry. In most cases, it is around 30 days.

Why should you keep the payment terms when using a trade credit? Otherwise, the same principle applies as for a bank loan, i.e. exceeding the repayment date is associated with the need to pay interest.

It means, therefore, that the entrepreneur may feel the costs of the trade credit if he does not pay the amounts due within the prescribed payment period.

What does the trade credit agreement look like?

A trade credit agreement may be made in writing, although there is no such legal obligation. It often takes oral form. However, it is better to protect yourself and make it in writing. What should it contain?

First of all, the data of the parties to the contract, the date of deferred payment, as well as its amount. The lending party may also require collateral. 

Discount – what does it mean?

One of the main instruments used with trade credit is a discount, i.e. a rebate. What is it exactly about? A discount is simply a percentage reduction in the price that the recipient receives if he pays for the goods immediately upon receipt.

In practice, it comes down to the recipient choosing one of two variants; either he chooses to pay instantly in cash or some other form (e.g. a check) and benefit in the form of a discount, or he chooses a trade credit, i.e. a deferred payment, in which the discount is no longer available.

Of course, obtaining a discount is not only the recipient’s decision, because his position in the legal relationship, characteristic of trade credit, is identical to that of the debtor, but the condition for obtaining such an option is also the creditor’s decision each time.

It is he who checks the credibility of the recipient and determines the rules for granting trade credit. It can be said that the lack of a discount is to some extent the cost of the trade credit that the entrepreneur agrees to when he decides to postpone the payment date for a good or service he has purchased.

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