Trade credit has always been a key part of B2B commerce. However, like any financial arrangement, trade credit involves a delicate balance of advantages and disadvantages that must be carefully considered.
In this article, we’ll explore the nuances of trade credit, and break down its key benefits and potential drawbacks.
Understanding Trade Credit
Trade credit is a financial arrangement between two businesses, where a supplier of goods or services extends a deferred payment option to its customer. This agreement allows the buyer to purchase products or services without the immediate need for cash, effectively granting a short-term, interest-free loan.
Advantages of Trade Credit
1. Cash Flow Benefits for Buyers
By granting buyers the option to defer payment, this frees up their working capital, allowing them to invest in inventory, equipment, or other growth opportunities. This financial flexibility can be particularly beneficial for buyers facing seasonal fluctuations, unpredictable cash flow patterns or other growth opportunities that require investment.
For example, a construction company that experiences a lull in sales during the winter months can leverage trade credit to acquire the necessary materials for the upcoming busy season, without depleting its immediate cash reserves.
For example, a garage that fixes cars can leverage trade credit to acquire parts upfront. This allows them to service their customer and be paid for their work first, before paying their parts supplier.
2. Increased Sales and Customer Loyalty
Extending trade credit to your customers can drive significant sales growth, attracting new clients and fostering long-term loyalty. By offering deferred payment terms, businesses can make their products or services more accessible to a broader customer base, particularly those with limited immediate financial resources.
This increased accessibility can translate into higher sales volumes, as customers are more likely to purchase in larger quantities or try other product lines. The trust and convenience associated with trade credit helps to establish loyalty between the merchant and buyer. If a merchant consistently offers trade credit, buyers will have less reason to find an alternative supplier.
3. Competitive Advantage
In highly competitive B2B markets, trade credit can serve as a significant differentiator, giving businesses a distinct edge over their rivals. Buyers often consider the availability and terms of trade credit as a key factor when selecting suppliers, making it a crucial consideration for companies seeking to gain a competitive advantage.
Offering trade credit is especially effective in differentiating commodity items that are widely available. When products are similar across suppliers, the ability to provide flexible payment terms can be a compelling reason for buyers to choose one company over another.
By offering more flexible or generous credit terms than competitors, businesses can attract a wider pool of buyers and potentially secure more lucrative contracts. This strategic use of trade credit can be particularly impactful in industries where cash flow constraints are common, such as construction or manufacturing.
4. Flexibility in Payment Terms
One of the key advantages of trade credit is the flexibility it offers in terms of payment schedules. Businesses can negotiate the specific deferment periods, ranging from short-term (e.g., 7 days) to longer-term (e.g., 60 or 90 days), based on their unique cash flow requirements and the nature of their industry.
This flexibility allows companies to better align their payment obligations with their revenue streams, enabling them to manage their finances more effectively. Additionally, some suppliers may offer early payment discounts or other incentives to encourage timely payments, further enhancing the appeal of trade credit.
Disadvantages of Trade Credit
While trade credit can undoubtedly provide numerous benefits, merchants should consider the potential drawbacks and risks associated with it. Understanding these disadvantages can help businesses make informed decisions.
1. Risk of Bad Debt
One of the main downsides with trade credit is the potential for bad debt, when buyers do not fulfil their payment obligations as agreed. This situation has the potential to result in financial losses for the merchant, as they may be forced to consider the outstanding debt as uncollectible and write it off.
In order to minimise this risk, suppliers should carefully evaluate the financial stability of their customers, conduct comprehensive background checks, and establish well-defined collection procedures. These processes take time & resources, and even when implemented, the potential for bad debt will always come with offering credit.
2. Impact on Cash Flow
While trade credit can enhance the cash flow of the customer, it can have the opposite effect on the supplier's financial position. By extending payment terms, suppliers are effectively granting their customers an interest-free loan, which can strain the supplier's own working capital and cash flow.
This can be particularly problematic if a significant portion of a supplier's sales are made on credit, as it may lead to delays in the supplier's ability to settle their own financial obligations, such as paying their own suppliers or meeting payroll requirements.
3. Credit Management Costs
Implementing and maintaining an effective trade credit system can incur significant administrative costs for the supplier. These include the expenses associated with conducting credit checks, generating and managing invoices, and overseeing the collection of outstanding payments.
Additionally, suppliers may need to allocate dedicated resources, such as credit management personnel, to handle the increased workload and ensure the smooth operation of the trade credit program. These administrative burdens can divert attention and resources away from other critical business functions, potentially impacting overall efficiency and profitability.
Many businesses may decide not to extend trade credit to their long-tail buyer base due to the combined administrative load and credit risk. For these merchants, using a "pay later" method, can be transformative. Automating credit decisions and collections will help businesses more effectively scale their long-tail buyer base. By letting consumers buy online, this self-service approach helps to lower administrative overhead and guarantee more seamless credit management practices.
4. Potential for Disputes
Trade credit agreements can sometimes lead to disputes between the supplier and the customer, particularly regarding payment terms, the quality of goods or services, or the conditions under which goods are delivered or returned. These disputes can escalate into legal issues, resulting in potential litigation costs and the potential for damaged business relationships.
To mitigate this risk, suppliers should ensure that their trade credit contracts are clear, comprehensive, and legally sound, outlining the rights and responsibilities of both parties. Proactive communication and a commitment to dispute resolution can also help maintain a harmonious working relationship between the supplier and the customer.
5. Dependency on Creditworthiness
The effectiveness of trade credit is heavily dependent on the creditworthiness of the buyer. Suppliers must carefully assess the financial stability and payment history of their buyers before extending credit, as a buyer’s inability to meet their financial obligations can have significant consequences for the supplier.
This dependency on buyer creditworthiness can limit the pool of potential customers for suppliers, as they may be hesitant to offer trade credit to businesses with poor credit profiles or limited trading histories. This, in turn, can restrict the supplier's ability to expand its buyer base and diversify its revenue streams.
6. It’s Slow and Offline
B2B commerce is evolving and buyers expect the immediacy and sophistication of consumer shopping. Yet, traditional trade credit, by contrast, is offline. Typically, it requires application forms to be processed, commonly taking several weeks for a buyer to find out if they have been eligible or not. Furthermore it is often only available for orders placed through offline channels, like telesales, email or wholesale.
For buyers used to accessing instant credit through eCommerce sites, traditional trade credit can feel frustratingly slow and cumbersome
Overcome the Limitations of Trade Credit with Kriya PayLater
Kriya PayLater presents merchants with the opportunity to provide flexible payment terms, while addressing the major downsides that come with trade credit, including delayed cash flow, associated credit risk & admin costs.
No Delayed Payments
Trade credit often involves waiting periods for payment, which can put a strain on the merchant’s cash flow. PayLater eliminates this issue by ensuring immediate payment upfront for the merchant, via a PayLater provider.
eCommerce/Online
Kriya PayLater enhances online sales by integrating seamlessly with your digital store. It provides a smooth checkout experience, allowing buyers to choose flexible payment terms directly on your website. This not only increases the likelihood of completing sales but also encourages higher-value purchases, improving your overall revenue.
Credit Risk
The merchant bears the risk of customers defaulting on payments under trade credit. With PayLater the merchant is protected as the credit risk is transferred to Kriya. Credit decisions are instant, with payment authentication handled seamlessly in a single payment flow.
Administrative Burden
Managing trade credit involves significant administrative tasks related to invoicing and collections. BNPL reduces this burden, allowing sellers to focus on their core business operations.
Buyer Adoption
Traditional trade credit is typically extended to well-established buyers with good credit histories. PayLater opens up purchasing opportunities to a wider range of customers, including those buyers who may incorrectly be deemed high risk by the merchant.
Powering your B2B growth.
Give buyers the choice to pay on their own terms and provide a seamless checkout experience with Kriya Paylater. We handle the transaction from end-to-end, with a frictionless buyer journey.
- Instant buyer authentication & spending limits set
- Flexible payment terms
- Kriya pays you in full on delivery of order
- Kriya takes on the risk & handles payment collection
PayLater is driving real growth for our merchants:
- 40% Buyer Adoption
- 45% Revenue Growth
- 4x Increase in acquisition of new buyers
Talk to our team today to find out more about how we can help you
