Trade Credit or Vendor Financing for Business Growth
If your business needs money for cash flow purposes, or for expansion, and getting one from a traditional lender isn't a possibility, consider vendor financing, sometimes called trade credit. This article explains how this type of credit works.
Vendor Financing and Trade Credit
Vendor financing and trade credit are often considered the same thing. You may find that different businesses mix them up, but for this article we'll discuss them as two different types of credit.
Vendor financing involves a loan or credit line directly from a vendor (a company you do business with), to be used to buy that company's inventory for your own business use. Vendor financing is a common practice for larger businesses.
Put it on My Account
Some suppliers call this an "open account," because they keep your account open and you can buy from them on credit as long as you continue to pay regularly. It's similar to the old-fashioned stores keeping track of purchases by a customer. In our world, that means the store setting up its own financing system for customers, often with a credit card or other credit arrangement.
Vendors can be:
- Service providers, such as a payroll service or cleaning service
- Suppliers, such as an office supply store or specialty supply house
- Equipment manufacturers
- A company that supplies parts or materials.
For example, you could go to an office supply business and set up an account and buy your office furniture, computer, and office supplies from this company. The vendor would require you to fill out a credit application and use the vendor's own credit card or financing company to check your credit and offer you financing terms.
Trade credit is slightly different because it usually involves terms of sale. It's more about how long you have to pay for the products you have purchased from the vendor.
Trade credit usually involves a sales invoice, in which the seller gives you a specific length of time to repay.
Some common invoice terms:
- Net 7, 10, 30, etc. The net (entire) amount is due within the specified number of days after the invoice date. Some businesses use "7 days" to avoid confusion.
- 2% 10, net 30: A 2% reduction in the amount if it's paid in full within 10 days of the invoice date, or the entire amount of the invoice payable within 30 days.
Using Trade Credit to Finance Your Business Start-up or Expansion
When you think about getting financing for business startup or for expansion, or for inventory financing, you usually think of going to a bank. But a bank may not be the best way to begin setting up your business. Trade credit can also be used to buy inventory for your startup. In this case, you might have to use a personal credit report, since your new business would not have a credit history.
Establishing Trade Credit
When you have set up the structure for your new business, start dealing with local suppliers for equipment, supplies, and inventory. In other words, obtain credit directly from suppliers, like office supply stores, specialty equipment suppliers for your business type, and inventory or materials. Ask each vendor if they will allow you to pay "on account" and then be sure you pay off the account each month. For larger national vendors, request one of their credit cards, and pay it off each month.
How Trade Credit Terms Work
Using trade credit can get your better terms on business-to-business purchases. Shari Waters, Retailing Expert, explains that businesses give favorable financing terms to good customers. She says:
Once it is established that a business can pay its bills on time, it is possible to negotiate trade credit and terms with suppliers.
These favorable trade credit terms might include discounts for paying a balance due early.
How Trade Credit Helps Your Business
Using trade credit does four things for your business:
- It helps you buy the things you need without having to go to a bank and use personal funds as collateral.
- It gives you a business credit rating to use when you need to go to a bank for a loan.
- It allows you to reserve the bank financing for capital improvements that will generate more returns.
It takes work to talk to many vendors and suppliers and to establish credit with each, but it pays off in the end, as you see your business credit rating improve and your ability to borrow money from a bank increase.