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Published 2nd February, 2023
Last updated 15th November, 2023
What is trade credit?
Trade credit is an important financial arrangement in the realm of business-to-business transactions. This flexible credit option allows businesses to offer customers the opportunity to obtain goods or services and settle the payment at a later date. Known by various names such as business credit, purchasing on invoice, or net terms, trade credit is a universally embraced financing tool that plays a pivotal role in the flow of commerce worldwide.
In fact, a report from Atradius revealed that up to 60% of B2B sales in the UK alone are facilitated through trade credit.
Trade credit is not just a financial tool though. It also fosters trust, promotes smoother transactions, and contributes to economic growth. By allowing customers to defer payments, suppliers allow their customers to grow their business, driving economic progress.
But how does trade credit actually work? What are the advantages and disadvantages of trade credit? And how does it compare to newer alternatives like B2B buy now, pay later?
We've collected all the useful information about trade credit so you don't have to! Continue reading to become a trade credit pro and learn how Two can help you improve cash flow, reduce admin, and boost B2B sales.
Table of contents
- How does trade credit work?
- The different types of trade credit
- What is trade credit insurance?
- Trade credit advantages
- Trade credit disadvantages
- Alternatives to trade credit
- What is a trade account in business?
- Why you need to offer trade credit
- Two - Hassle-free B2B payment solutions
How does trade credit work?
When you offer a buyer trade credit, you’re allowing them to purchase goods and pay you at a later date. The process for actually setting this up can vary greatly, but generally these are the basic steps of how B2B trade credit works:
- Assessment: A business offering trade credit needs to evaluate the creditworthiness of the buyer, considering factors like financial stability, payment history, references, and legal obligations.
- Credit Limit: Based on the evaluation, the seller determines the maximum credit amount they are willing to extend to the buyer.
- Terms: The seller establishes specific payment terms and conditions, including the payment period (e.g., 30 days, 60 days).
- Payment: The buyer receives the goods or services on credit and is expected to make payments within the specified payment period. The seller then sends invoices and follows up on collections if needed.
More recently, this process has been outsourced to advanced financial technology, making trade credit a whole lot easier to manage as a business. Two for example, covers all four of these steps!
Is trade credit a form of short term financing?
The short answer is yes but "short term financing" can also include things like credit cards, SBA loans, and working capital loans. Trade credit specifically refers to the agreement between a seller and buyer to secure goods or services and pay at a later date. There are actually several different forms of trade credit which are detailed below.
Trade credit advantages
So, what are some of the advantages of trade credit? One advantage is that it allows B2B buyers to secure a product or service, manufacture what they need and then make a profit - all before making a payment. This means their cash flow is much easier to manage.
Of course, the advantages aren’t just limited to buyers. Trade credit can be leveraged to boost B2B sales by giving customers an attractive financing alternative.
Let’s explore in more detail.
Sellers
Increased sales
By offering trade credit, you’re giving customers the opportunity to purchase more easily from you. Offering trade credit is a great way of generating more sales. In fact, 55% of all B2B sales are on trade credit in Western Europe.
Win new customers
Many of your potential customers are simply not in the position to purchase from you without trade credit. One of the other benefits of trade credit is that you’re able to capitalise on a whole market of buyers previously unavailable to you. In Eastern Europe for example, 40% of businesses offer trade credit to win new business.
Increased customer loyalty
With any credit agreement, there is a certain level of trust involved. As a merchant, you are responsible for either credit checking the customer yourself or working with a third party to do it for you.
But that doesn’t mean there’s no risk, and the customer knows that. Extending this trust towards your customers helps to build customer loyalty and increase repeat business over time.
Buyers
Improved cash flow
Being able to obtain inventory and generate income from the product or service they create before paying for goods is a huge win for sellers. Cash flow is much more easily managed as the term length gives them the opportunity to generate sales and use the profits to settle their debts.
Increased purchasing power
Without trade credit, buyers have little option but to pay then and there for what they need. Purchasing on trade credit however allows B2B buyers to increase their purchasing power and acquire the resources they need to grow their business.
Affordable financing
Compared to other financing options for buyers like bank loans or credit cards, trade credit is far more affordable. If fact, it's free for buyers! Late payment fees will of course apply, depending on the agreement they have with the seller. But using trade credit is a free process.
When it comes to the advantages of trade credit, buyers get plenty of perks, and Sellers aren't left behind either. Trade credit helps build solid, long-lasting partnerships, encouraging both parties to work together.
Trade credit disadvantages
Sellers
Cash flow issues
With trade credit, you’re effectively postponing when you get paid, leading to cash flow issues. The reality is you’ll have to run your business without that income until you receive payment. This means it’s super important to record accounts receivables as an asset on your balance sheet, helping you keep track of what you’re owed.
To reconcile these issues, many B2B companies turn to a few different solutions. For example, you could:
- Apply for a credit line through your bank.
- Access tied up working capital using accounts receivable financing or debt factoring
- Use a B2B payment solution like Two. We’ll jump into how Two can fix these problems and more in just a bit.
Credit and fraud risk
As a merchant, you take on the credit and fraud risk for trade credit purchases. Any B2B sale on trade credit runs the risk of non-payments which can have dire consequences for your cash flow and business as a whole.
Struggling with cash flow? A 2022 Barclays study revealed that 58% of SMEs experienced late invoice payments from customers, so you're not alone. Download our free CFO's guide to Buy Now, Pay Later for B2B ebook to learn more about upfront payments, reduced admin, and improved operational efficiency.
Fortunately, there are trade credit insurers, as mentioned earlier. This will help cover any non-payments from your buyers and protect your business.
You’ll also need to establish the buyer’s creditworthiness. Less formal operations often make that assessment internally based on existing relationships, but it can be risky. There are credit risk management companies out there too to help you manage this more comprehensively.
Operational complexity
Managing invoices in-house requires time and effort and unless you have a dedicated team to deal with this, you’ll find a lot of your time can be spent organising paperwork. This means manually filling out invoices, sending them to your buyers, and reconciling payments. All of which can be an operational struggle.
Late payments
In the UK, a 2022 Barclays study revealed that 58% of SMEs experienced late invoice payments from customers. For medium-sized enterprises with 50 to 249 staff, the number waiting on late payments soared to 94%. These unpaid invoices can disrupt a seller's cash flow, making it difficult to meet their own financial obligations, including paying suppliers, employees, and operational expenses.
Late payments not only strain a seller's cash flow but can also jeopardise their business relationships and long-term stability. Exploring new revenue streams can provide additional avenues for businesses to bolster their financial health and mitigate the risks associated with trade credit.
In an effort to mitigate the impact of late payments, sellers often resort to credit checks on their customers, filtering out those with a history of paying late. Additionally, some B2B merchants offer incentives for early payments by providing discounts to buyers who settle their bills ahead of schedule.
However, even with these precautions, sellers must maintain an effective accounts receivable process to proactively address overdue payments and keep their financial operations running smoothly. Late payments not only strain their cash flow but can also jeopardise their business relationships and long-term stability.
Buyers
Late payment fees
In the business world, getting paid on time isn't always a sure thing. The pandemic has made it even more common for buyers to delay payments. In fact, around 47% of invoices are paid late. When buyers don't pay on time, sellers might charge them a late payment fee. This can be a problem, especially if sellers also struggle with their own bills. So, it's important for buyers to stick to the payment agreement and avoid these extra charges. Good communication and sticking to payment schedules can help keep things simple and smooth.
Damaged reputation
If a buyer doesn’t pay their invoice in the allocated term, it’s common for sellers to charge them a late payment fee. Sellers struggling with cash flow can find themselves unable to pay their invoices on time, resulting in further charges they need to pay.
Alternatives to trade credit
Trade credit (and the different versions of trade credit) can be used to a company's advantage depending on their needs, future goals, and resources. But trade credit isn't for everyone. In fact, the rise of B2B BNPL has driven many businesses to offer their customers this alternative form of financing. Let's take a look at some of the alternatives to trade credit currently available to businesses:
Bank loans
Businesses seeking financing have the option of approaching banks and financial institutions for various types of loans, such as term loans, lines of credit, or asset-based loans. These loans provide upfront capital that can be utilised for diverse purposes, including purchasing inventory or funding business operations.
The key difference between bank loans and traditional trade credit is simply the barrier of entry. Obtaining a business loan from banks typically involves time-consuming paperwork and checks. Loans may come with high-interest rates or require collateral as security. In contrast, trade credit is provided by suppliers directly to their customers when needed, without any exchange of collateral or interest rates.
Accounts receivable financing
Accounts receivable financing, also known as trade receivables financing or AR financing, offers a short-term funding method for businesses. It allows them to borrow capital against the value of their accounts receivables. This approach enhances cash flow and enables businesses to continue operations smoothly, even with tied-up capital in receivables.
Debt factoring
One of the most popular ways for B2B firms to get paid quickly is with debt factoring. This is where a third party, such as a bank or financial service provider, will quickly pay you 80-90% of the invoice amount upfront, and then collect it from the buyer when the payment terms expire. This alternative provides businesses with quick access to working capital while transferring the collection risk to the financing provider.
Supply chain financing
Supply chain financing operates similarly to invoice factoring, but with a reversed approach. Instead of the merchant seeking early payment on their invoice, the buyer obtains financing, allowing their supplier to receive early payment. This facilitates smooth cash flow along the supply chain and is often referred to as "reverse factoring."
B2B Buy Now Pay Later
B2B Buy Now Pay Later (BNPL) is a form of short-term financing that permits business buyers to defer payment or divide purchase costs over a specific period. Similar to its B2C counterpart, B2B BNPL provides interest-free trade credit to the buyer while ensuring the seller receives upfront payment, all while helping to mitigate the credit risk associated with net term payments.
What is a trade account in business?
Business trade accounts allow a company to purchase goods or services on credit from another company. This means they can receive the goods or services now and pay for them at a later date, usually with interest.
Trade accounts are commonly used in industries such as manufacturing, retail, and wholesale, where large volumes of goods or services are exchanged between businesses. They can help businesses to manage cash flow, build relationships with suppliers and customers, and simplify the buying and selling process.
How to get a trade account
The process of setting up a trade account can be a tedious experience. You want to make it as easy as possible for your B2B customers to purchase from you using trade credit. We’ve covered the advantages and disadvantages of trade credit for both you and your customers, but it’s worth reiterating again;
The sheer time it takes to get a customer up and running with trade credit can drastically impact your business. Manual onboarding and credit checks slow the entire purchasing journey down when you could be selling.
But with Two, it happens in seconds!
Why you need to offer trade credit
While COVID-19 put the world on pause for 2 years, some positive advances in the B2B space emerged. The BNPL B2C model is making its way over to B2B and now, more and more business customers are expecting an experience akin to their B2C purchases.
This can be partly explained by how familiar B2B buyers are with financial technology. Given 73% of all professional B2B purchasing decisions are made by millennials, the increasing assumption is that B2B companies will offer the same seamless purchasing experience as B2C.
And that includes offering net terms. For example, a study by McKinsey found that 96% of B2B buyers might make a purchase in a fully end-to-end, digital self-serve model. Offering trade credit becomes not just preferable but expected by B2B buyers and one of the leading reasons you should offer B2B trade credit solutions.
Further reading
- The Different Types of Trade Credit: A Comprehensive Guide
- B2B Buy Now Pay Later vs Traditional Trade Credit
Two - Hassle free B2B payment solutions
Two offers a range of B2B payment solutions to make it easier than ever to offer integrated trade credit directly at the checkout to boost B2B sales, improve cash flow, and offset credit risk*.
*Two may not provide the credit or fraud risk assessment depending on certain variables such as market or solution chosen.
E-Commerce Checkout
With support for some of the most popular E-Commerce platforms like WooCommerce, Magento, and CraftCMS, Two’s E-Commerce Checkout gets you up and running straight away. Or you can integrate directly with our API.
Two’s E-Commerce Checkout allows you to offer a frictionless checkout experience for your customers to increase B2B sales and conversion rates. And with a 90% acceptance rate, you can say goodbye to turning customers away. In fact, this apple reseller was rejecting 52% of their potential B2B customers before using Two.
Trade Account
Onboarding customers in the traditional way is manual and time-consuming. The long it takes to get them up and running, the higher the chances they’ll abandon their basket and choose a competitor.
Two’s Trade Account provides you with a frictionless customer-onboarding experience, integrated right into your sign up flow. Customers simply fill in their details, apply for credit, and checkout in 30 seconds. In fact, Trade Account users see an 18x increase in customer retention and 11x more orders per buyer!
Plus, true one-click purchasing makes buying from you a walk in the park. With features like Grouped Invoices, your customers can receive a single invoice per purchase or grouped into weekly, fortnightly, or monthly invoices to drastically reduce admin!
Order Creator
Omnichannel selling has become increasingly popular in B2B. In fact, B2B customers now regularly use ten or more channels to interact with suppliers. But can your field sales or tele-sales team offer instant trade credit as easily as your e-commerce store?
Two’s Order Creator makes it simple to offer invoice purchases to all B2B customers, because sales don’t just happen in one place. Capture offline sales and get paid upfront by harnessing the total power of Two for all B2B sales.
Instalments
Selling B2B rental services or subscription plans can be tough. In fact, only 3.8% of SaaS businesses offer annual plans as a result. Other than creating needless cash flow problems, this means B2B sales suffer.
Let your customers split payments for purchases over 3 to 24 months with Instalments. Boost B2B sales for rental services, subscription plans, and big-ticket items to drastically improve cash flow and increase B2B sales. All while Two handles the admin.
