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Trade Credit: How to Determine if You Should Offer Net-30
Terms to Your Customers
What is trade credit?
One of the major differences between consumer and commercial
transactions is that most, if not all, consumer transactions are
paid in cash or by credit card at the time of sale. Because of
this, most consumer businesses never have to worry about
extending credit to a customer and can run their operations on an
"all cash" basis. This allows them to focus on their core
competencies because they don't have to carry slow paying
Accounts Receivables and go through the expense of collecting on
such accounts.
However, commercial transactions are different. Most clients
ask their suppliers to deliver services immediately and then to
invoice them for the work, payable 30 days later (also known as
offering net-30). In effect, clients ask their suppliers provide
them with "trade credit" for 30 days. Although suppliers don't
like offering trade credit, most have accepted it as an industry
standard and have learned how to operate and live with it. In
fact, some suppliers have even mastered how to offer trade credit
and use it to better position their companies with leading
clients. Large creditworthy customers, such as the government or
large companies, will usually demand trade credit as part of
their contract negotiations. Some examples of entities that ask
for 30 to 60 day payment terms are:
o Fortune 500 companies
o Large and medium sized companies
o State government agencies
o Federal government agencies
On the positive side, providing trade credit to the proper
clients can be a tool that allows your company to win important
contracts and position it for growth. However, providing credit
is also risky and can erode the company's cash position if it is
misused. Furthermore, offering trade credit to
less-than-creditworthy clients can burden the company with bad
debt and affect its growth prospects. Because of this, business
owners must walk a fine line balancing their desires to grow
their businesses with the necessities of offering credit to their
customers.
Keys to providing trade credit successfully
The best way to minimize the risk of providing trade credit to
a client is to perform a credit analysis on him. Although no
credit analysis is 100% perfect, they allow business owners to
make an informed decision on whom to issue credit to. Here are
the three key points to making a credit analysis.
o Have the customer fill out a credit application
Have all your customers that want credit fill out a simple credit
application. This will allow you to have all relevant facts in a
single document. The application should ask for the following
information:
1. Company structure
2. Banking relationships
3. Commercial references
4. Supplier references
o Check bank and supplier references
In their credit applications most clients will only list banking
and commercial relationships that will position them in a
favorable light - however - it is always a good idea to check on
all of them anyway. Banks will only be able to confirm that the
client has an account with them. Supplier references, however,
may provide critical information regarding the clients' payment
habits.
o Check commercial credit reports
There are a number of companies that sell commercial credit
reports on businesses. As opposed to consumer credit reports that
require special permissions, commercial credit reports can be
obtained for any business without asking for prior permission.
Reports vary in their level of detail and accuracy and can be
obtained for as little as a few dollars. However, all reports
will include important information to help your credit department
make a decision. More detailed reports will cost a few hundred
dollars. You can obtain credit reports from the following
companies:
a) Dun & Bradstreet (www.dnb.com)
b) Experian (www.experian.com)
c) Credit.net (www.credit.net)
Doing a credit analysis on your clients will allow you to
determine how much - if any - trade credit you can give them.
Clients that do not have a favorable credit analysis should be
placed on a COD (Cash On Delivery) basis, at least initially, to
reduce the risk of non-payments.
The challenges of offering trade credit
One of the main drawbacks of providing trade credit is that it
can create a cash flow problem for the company that offers it.
Large suppliers with adequate cash cushions in the bank can
easily afford to offer credit. However, small suppliers with lean
bank accounts usually find that offering credit will drain their
cash resources and create financial challenges. It is not
uncommon for small businesses to find themselves with a cash flow
gap after offering trade credit to their larger clients. This gap
is created by the fact that the company's Accounts Receivable
account is strong while the company's bank accounts and cash
position are weak. The cash flow gap places the business at risk
of missing payroll and debt payments. It also prevents it from
pursuing new opportunities because they don't have the funds to
buy resources or hire the necessary staff.
Bridging the "cash flow" gap
The biggest asset that most new businesses have, aside from
their equipment and intangibles (e.g. employees), is their unpaid
invoices or Accounts Receivable. Accounts Receivable is an asset
that can be quickly converted into cash by using a financial tool
called factoring. Factoring allows a business to sell the
financial rights to their Accounts Receivable to a third party,
called a Factor. As part of the sale, the factor immediately
advances a large portion of the cash value of the unpaid invoices
to the business. The business can then use this cash infusion to
strengthen its cash position and meet its obligations. In the
meantime, the factor, which now owns the invoices, waits to get
paid by the customer. Factoring enables business owners to
outsource their trade credit function to the factor and to turn
their companies into the equivalent of an "all cash" business. If
you want to learn more about factoring and how it can be used to
grow your business, please read our white paper titled
"Factoring: Cash on Demand for your business without debt or
loans"
About Marco Terry
Marco Terry is president of Commercial Capital LLC, a leading
commercial finance company that specializes in providing working
capital through factoring to small businesses. For more
information or a free consultation, please visit our web site at
http://factoring.ccapital.net
or call us at (786) 206 4722.
MORE RESOURCES:
Credit - Google News
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