Trade Credit: What It Is, How It Works

Trade credit is a simple and effective way where businesses help each other manage cash flow and grow. It’s an agreement where a buyer can purchase goods or services and pay the supplier at a later date. This arrangement helps businesses maintain steady operations without immediate financial strain. In this article, we would explore the concept of trade credit, its types, benefits, risks, and how personal loan services can be beneficial in managing trade credit. 

What is Trade Credit?

Trade credit is a short-term credit extended by suppliers to their customers, thereby, allowing them to purchase goods or services and pay for them at a future date. It’s a common practice in the business world and helps companies manage their finances more effectively.

Types of Trade Credit

Open Account

In an open account arrangement, the seller ships the goods and invoices the buyer. The buyer agrees to pay the invoice within a specified period, usually 30, 60, or 90 days.

Promissory Note

This type involves a formal written promise by the buyer to pay the seller a certain amount by a specific date. It’s more binding than an open account.

Bill of Exchange

A bill of exchange is a written order used in international trade requiring the buyer to pay a fixed amount at a predetermined future date.

How Trade Credit Works

Trade credit operates on mutual trust between the supplier and the buyer. Here’s a step-by-step process of how it typically works:

Agreement: The supplier and buyer agree on the credit terms, such as the amount of credit, payment period, and any discounts for early payment.

Purchase and Delivery: The buyer places an order, and the supplier delivers the goods or services without immediate payment.

Invoicing: The supplier sends an invoice to the buyer, detailing the amount owed and the due date.

Payment: The buyer pays the invoice within the agreed period, completing the trade credit transaction.

Also Read: What is Letter of Credit? How does it work?

Benefits of Trade Credit

Improved Cash Flow

Trade credit allows businesses to purchase goods and services without immediate payment, freeing up cash for other needs.

Business Growth

Companies can expand their operations and increase inventory without requiring immediate capital outlay.

Building Relationships

Regular use of trade credit can strengthen the relationship between suppliers and buyers, leading to better terms and conditions.

Flexibility

It provides flexibility in managing finances, enabling businesses to take advantage of opportunities without worrying about immediate cash availability.

Risks of Trade Credit

Non-Payment

There’s always a risk that the buyer may not pay the invoice on time, or at all, which can affect the supplier’s cash flow.

Creditworthiness

Suppliers need to assess the creditworthiness of their buyers to reduce the risk of default.

Administrative Costs

Managing trade credit involves administrative efforts and costs, such as monitoring outstanding invoices and following up on payments.

Managing Trade Credit

Effective management of trade credit involves careful planning and monitoring. Here are some tips:

Credit Checks: Conduct thorough credit checks on new customers to assess their financial stability and payment history.

Clear Terms: Set clear credit terms and ensure both parties understand and agree to them.

Regular Follow-Up: Regularly follow up with customers to remind them of upcoming due dates and to manage any potential issues early.

Use of Technology: Utilise accounting software to track invoices and payments efficiently.

Airtel Personal Loan and Trade Credit

Airtel offers personal loans that can be a valuable resource for businesses managing trade credit. If a company needs immediate funds to pay suppliers or manage cash flow, Airtel’s personal loan services can provide quick and easy access to the required capital. This can help businesses maintain good relationships with their suppliers and take advantage of early payment discounts.

Also Read: How to Choose the Best Personal Loan lender?

Conclusion

Trade credit is a significant financial tool that facilitates smoother business operations and growth by allowing purchases on credit terms. While it offers numerous benefits, it also comes with risks that require careful management. Companies can leverage services like Airtel’s personal instant loans to manage their cash flow effectively and ensure they meet their trade credit obligations. 

Also, the Airtel Thanks app can be a handy tool for managing these financial aspects, offering easy access to various financial services and monitoring transactions on the go.