Trade Credit: An Alternative Source of Business Funding

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If a business cannot obtain all of its desired funding from banks, it is likely and logical that the business will turn to alternative sources of funds.

Using Trade Credit As An Alternative Source of Business Funding

trade or vendor credit sources - home depot

Trade Credit plays a critical role in strengthening relationships between banking institutions and businesses seeking funding. Many trade credit vendors report information about business creditworthiness to a central database such as Dun & Bradstreet or Experian Business. Similar to how FICO and VantageScore measure an individual’s creditworthiness, business creditworthiness is measured by Paydex and Intelliscore ratings. Having a Paydex or Intelliscore of 80 or better gives businesses better opportunities, such as:

  1. Better chance of loan approval
  2. Typically approved for higher dollar amounts
  3. Lower interest rates on loans and credit lines

Trade Credit is a substantial part of the Optimal Financing Mix

A Small Business survey conducted by the National Federation of Independent Business (NFIB) asked respondents to rank Source of Funds in order of importance. The following shows the respondents rankings:

1.    Credit Cards
2.    Trade Credit / Vendor Credit
3.    Bank Loans & Credit Lines
4.    Retained Earnings (Profits)

The role of Trade Credit in a Business’s capital structure can play a vital role in managing cash flow. This is especially true when bank loans or credit lines are not available. Here are some other characteristics of Trade Credit:

  • Trade Credit can be used to finance a portion of a firm’s investments in inventory or accounts receivable.
  • Trade Credit allows a business to better match the timing of cash outlays for the cost of goods sold with the cash receipts from sales.
  • Trade Credit plays a critical role in a firm’s quality control efforts by allowing them to verify product quality before paying.
  • Due to its revolving nature, a business can find it less costly to delay Trade Credit payments than to renegotiate the payment terms of bank loans.
  • Delayed Trade Credit payments could help fund capital investments.
  • Suppliers encourage early payment with incentives, such as discounts for invoices paid within a certain time.
  • Terms are usually Net 30 or Revolving.
  • Revolving terms are much more valuable and desirable since you do not have to pay the balance in full.
  • There’s virtually no end to the number of vendors you could establish trade accounts with. The only catch is that not all businesses offer these types of business credit accounts.
  • Net 30 terms basically have no “cost” but could assess fees in some cases if they are not paid within the 30 days. Some offer 2% discounts if the invoice is paid within 10 days.
  • Companies that issue trade credit with revolving terms typically have high APR’s or annual percentage rates. Companies like Dell, Staples, Home Depot, Wal-Mart, Exxon, and Shell all offer revolving terms and you’ll likely see APR’s from 14-29%.
  • With trade credit, your personal credit profile and scores are typically less important and often times irrelevant.
  • You can obtain trade credit as a new business, although it is more challenging and does require a plan or a strategy that knows which businesses to set these accounts up with first.
  • You will rarely need full financials to establish trade credit.

Trade Credit is the easiest of the 3 Unsecured Business Lines (UBLs) to obtain. Getting favorable terms can be invaluable as you build your business. It’s also important to note that favorable terms should be thought of in terms of cash-flow more than in terms of the interest rate. In other words, would you prefer a rate of 13% with a lower monthly payment, or a rate of 9% with a much higher monthly payment?  Most bootstrapping businesses would prefer the lower payments. Look for “cash-flow friendly” financing as you’re seeking out business capital.

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