Summary
Here is a trade credit definition: an agreement between two B2B companies, where a supplier of goods or services accepts a deferred payment from its client.
A trade credit agreement does not cost your customer anything: they do not pay any fees or interest.
A trade credit agreement is a sort of 0%-loan – referred to as a “commercial loan” – that you grant your customer when invoicing a product.
When making this agreement, you need to define invoice payment terms to provide details about the expected payment and specify how much time your customer has to pay.
The deferments granted generally range from one week to three months, and are counted in number of days (7, 10, 30, 60...).
At times, you may set up a discount to your customer in case of early payment.
Example. A client is granted a trade credit with terms of “5/10 net 30”: if payment is made within 10 days, the client is offered a 5% discount. If not, the full amount is due within 30 days.
Conversely, penalties for failure to meet payment deadlines can be set against a bad payer, usually through interests (around 8-10%) on the outstanding debt owed from the day after the due date of your contract. In certain cases, you can also ask to get compensation for business debt collection costs.
In many countries like in the European Union, such penalties are statutory and benefit from a regulatory framework. You should check the laws that apply to your contract before setting your payment terms.
Trade Credit Accounting
Both sellers and buyers are responsible for accounting for trade credits. The accounting with trade credits may vary depending on whether a company follows cash accounting or accrual accounting.
Accrual accounting is mandatory for all publicly traded companies. Under accrual accounting, a company is obligated to recognize revenues and expenses when they are incurred.
Trade credit invoicing can make accrual accounting more complex as companies must account for the assets as accounts receivable on their balance sheet.
Trade credit can also help companies to finance their current operations, especially during certain periods of high activity (for example a retailer as the holidays draw near). It’s also very useful for new businesses or startups which don’t have yet access to bank loans or sufficient fundraising.
On paper, trade credit looks like free money to the client. However, failure to meet payment schedules can result in major penalties according to the negotiated terms as well as damage the client's reputation and its relationship with the supplier.
The advantages mentioned above are crucial for certain industries, notably those with strong inventory costs and challenges – for example distribution or construction: trade credit helps the client finance its inventory with its working capital.
All sizes of business can benefit from it, although mid-sized companies are best positioned to benefit from the advantages of trade credit: they have greater bargaining power than SMEs, but fewer financing options than large companies.
In mass distribution, the negotiating power of major stores is strong. A company like Walmart in the USA is known to negotiate tough payment terms with its suppliers.
On your side of things, trade credit has multiple advantages: it is an effective way for you to win new contracts, increase your business volume and build loyalty among your clients.
Still, trade credit also has its disadvantages. A commercial loan is an account receivable that weighs on your working capital and cash flow: it is cash that is not collected on the date of invoicing.
Above all, you expose yourself to late payment or non-payment. This is bad debt potentially very difficult to recover, especially if your client goes insolvent or bankrupt.
To manage such trade risks, good cash flow management is key. For detailed tips and advice on cash flow, you can download our ebook how to protect your cash flow.
Another solution is trade credit insurance. It provides you with predictive protection and compensation in the event of a bad debt. Concretely, it means that if a client doesn’t pay you on time, the insurer will reimburse a percentage of the outstanding credit. This type of coverage is very flexible and can cover all or part of your client portfolio.
Other risk solutions make it possible to have your account receivables financed while they are being collected, or even to assign them to a third party. Each solution has its own advantages and disadvantages.
In conclusion, trade credit is a powerful credit management tool for you to accelerate your commercial development and improve your customer relations, with limited risk if properly controlled. Solutions like trade credit insurance prove very useful and efficient for managing trade receivables and taking full advantage of the benefits of trade credit.
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Our expertise and commitment
Allianz Trade is the global leader in trade credit insurance and credit management, offering tailored solutions to mitigate the risks associated withbad debt, thereby ensuring the financial stability of businesses. Our products and services help companies with risk management, cash flow management, accounts receivables protection, Surety bonds, business fraud Insurance, debt collection processes and e-commerce credit insurance ensuring the financial resilience for our client’s businesses. Our expertise in risk mitigation and finance positions us as trusted advisors, enabling businesses aspiring for global success to expand into international markets with confidence.
Our business is built on supporting relationships between people and organizations, relationships that extend across frontiers of all kinds - geographical, financial, industrial, and more. We are constantly aware that our work has an impact on the communities we serve and that we have a duty to help and support others. At Allianz Trade, we are strongly committed to fairness for all without discrimination, among our own people and in our many relationships with those outside our business.