The advantages and disadvantages of offering trade credit

Trade credit is an essential tool if you want to conquer new markets and build long-term relationships with your buyers. While indispensable in sectors like distribution and construction, trade credit can also involve risks. The good news? There are effective ways to control them. This guide covers what trade credit is, how it works for both suppliers and buyers, and how solutions like trade credit insurance can protect your cash flow.

Trade credit is a business-to-business (B2B) arrangement where a supplier allows a buyer to receive goods or services now and pay later, typically within 30 to 90 days. This credit agreement is essentially a free loan from sellers to buyers—there are no fees or interest charges if payment is made by the agreed deadline.

When you extend trade credit to your customers, you're giving them short-term financing that supports their cash flow and operations. The arrangement is recorded as accounts receivable on your balance sheet and accounts payable on your customer's balance sheet.

To make this work, you need to define invoice payment terms that specify exactly when payment is due and any conditions that apply. Common terms include net 30, net 60, or net 90 days, meaning payment is due within that timeframe from the invoice date.

You can also offer early payment discounts to encourage faster settlement. For instance, terms of "2/10 net 30" mean your customer can take a 2% discount if they pay within 10 days, or pay the full amount within 30 days. This arrangement helps the retailer manage cash flow while the wholesaler builds customer loyalty and increases sales volume.

Here's a practical scenario: A wholesaler supplies £10,000 worth of inventory to a retailer on net 30-day terms. The retailer receives the goods immediately but has 30 days to pay the invoice. If the wholesaler offers 2/10 net 30 terms, the retailer can pay £9,800 (saving £200) by settling within 10 days. If they wait the full 30 days, they pay the full £10,000. This arrangement helps the retailer manage cash flow while the wholesaler builds customer loyalty and increases sales volume.

At its core, trade credit follows a straightforward process that helps buyers and suppliers manage transactions and cash flow. Here's how it works in practice:

1. Agreement and terms: You and your customer agree on payment terms (for example, net 30 or net 60 days) before goods or services are delivered.
2. Delivery and invoicing: You deliver the goods or services and issue an invoice showing the amount owed and payment deadline.
3. Payment period: Your customer has the agreed period to settle the invoice, during which they can use the funds for other business needs.
4. Settlement: Once the payment deadline arrives, your customer pays the invoice (or earlier if they want to take advantage of any early payment discount you've offered).

This process creates accounts receivable on your books and accounts payable on your customer's balance sheet, with the transaction typically recorded at the time of delivery under accrual accounting.

From your customer's perspective, trade credit acts as a short-term financing tool that helps manage cash flow without needing to tap into bank loans or credit lines. When they receive goods or services, the invoice becomes an account payable on their balance sheet, which forms part of their working capital.

Unlike bank financing, which involves interest charges, formal loan agreements, and often requires collateral, trade credit offers a direct arrangement between you and your customer. If they pay within the agreed terms, there's no cost to them. This makes it particularly valuable for businesses with limited access to traditional financing or those looking to preserve cash for other priorities like payroll or expansion.

When you offer trade credit, you're essentially providing commercial financing to your customers. This differs from other financing options in a few key ways. Bank loans involve formal lending with interest, repayment schedules, and credit checks, while trade credit is more flexible and built into your sales process.

For your customers, trade credit can complement or even substitute for bank financing, especially when they face cash flow pressure or want to avoid taking on formal debt. For you as the supplier, it's a competitive tool that can help you win contracts and build loyalty, though it does mean you'll need to manage the cash tied up in receivables until payment arrives.

Both BNPL and trade credit let buyers receive goods or services and pay later — but the way they work is quite different.

With trade credit, the supplier extends credit directly to the buyer. There's no third party involved. Payment terms (typically 30, 60, or 90 days) are agreed between you and your customer, and the credit risk stays on your books until the invoice is settled.

BNPL, on the other hand, brings in a third-party provider — such as Allianz Trade pay — who pays you upfront and then collects repayments from your buyer. This means you get paid immediately, and the credit risk shifts away from you.

Trade credit payment terms can range from one week to three months, counted in days such as 7, 10, 30, 60, or 90. These terms define how long your customer has to settle the invoice after receiving goods or services.

You can encourage faster payment by offering an early payment discount. For example, terms of "5/10 net 30" mean your client receives a 5% discount if they pay within 10 days. If not, the full outstanding amount is due within 30 days. This approach helps improve your cash flow while giving your customer a financial incentive to pay promptly.

If payment deadlines aren't met, you can apply late fees to encourage timely settlement. For example, interest of around 8-10% may be charged on the outstanding debt from the day after the due date. This extra cost compensates you for the delay and helps protect your cash flow. In some cases, you can also claim compensation for debt collection costs.

In many countries, including those in the European Union, late payment penalties are supported by regulatory frameworks that protect suppliers. You should always check the laws that apply to your contract before setting your payment terms to ensure they're enforceable.

Key advantages for buyers

Trade credit is an important source of commercial financing for your customers. When you offer trade credit, it becomes part of their working capital, directly improving their cash flow position.

For buyers, the main advantages include:

• Zero-cost financing when paid on time: Unlike bank financing, trade credit doesn't charge interest if invoices are settled within the agreed terms. It's essentially a 0% loan that frees up cash for other priorities.
• Improved cash flow management: Deferred payment terms allow businesses to sell products before paying suppliers, which means they can generate revenue before the invoice becomes due.
• Support during high-activity periods: Trade credit helps companies finance current operations during busy seasons (for example, retailers preparing for the holidays) without tapping into cash reserves.
• Access for businesses with limited financing options: Trade credit is particularly useful for new businesses or startups that don't yet have access to traditional bank financing or sufficient fundraising.
• Stronger supplier relationships: Paying on time can build trust and loyalty, potentially leading to better terms or priority service in the future.

Potential disadvantages to consider

While trade credit appears to be free money on paper, it does carry risks for buyers who don't manage it carefully.

The main disadvantages include:

• Penalties for late payment: Missing payment deadlines can result in major penalties according to the negotiated terms, typically around 8-10% interest on the outstanding amount. These charges can quickly add up and make trade credit far more expensive than other financing options.
• Damage to credit rating and reputation: Late or missed payments can harm your customer's credit profile, making it harder to access future financing or negotiate favourable terms with other suppliers.
• Strained supplier relationships: Failing to meet payment schedules can damage the buyer-supplier relationship, potentially leading to stricter terms, reduced credit limits, or even refusal of future trade credit.
• Risk of over-reliance: Businesses that become too dependent on supplier credit may struggle if terms change or if multiple invoices come due at once, creating unexpected cash flow pressure.

Trade credit is valuable across many B2B sectors, but certain industries rely on it more heavily. Businesses with strong inventory costs, such as distribution, construction, manufacturing, wholesale, and retail, can benefit particularly because trade credit helps finance stock and materials through working capital. Service providers also use trade credit to procure supplies or subcontractor services before generating revenue from completed projects.

Before extending trade credit, suppliers typically run a credit check on the buyer to assess creditworthiness and determine appropriate payment terms. This helps manage risk and ensures the buyer has a solid track record of meeting payment obligations. For smaller businesses looking to protect against non-payment risk, trade credit insurance for small businesses can provide valuable protection.

Advantages of offering trade credit as a supplier

When you offer trade credit to your customers, you unlock several strategic benefits that can strengthen your market position and drive growth:

• Win new contracts and attract buyers: Many businesses prefer suppliers who offer flexible payment terms. By extending trade credit, you make it easier for potential customers to choose you over competitors who require immediate payment.
• Increase your business volume: Trade credit removes cash flow barriers for buyers, which means they can place larger orders or purchase more frequently. This directly boosts your sales and revenue.
• Build customer loyalty and long-term relationships: Offering open accounts creates trust and demonstrates confidence in your customers. This encourages repeat business and helps you develop stronger, more profitable partnerships over time.
• Gain a competitive advantage: In markets where trade credit is standard practice, offering favourable payment terms can differentiate you from competitors and position your business as a preferred supplier.

Disadvantages and risks for sellers

While trade credit can drive growth, it also introduces real financial and operational challenges that you need to manage carefully:

• Impact on working capital and cash flow: When you extend credit, you're essentially providing an interest-free loan to your buyer. That's cash tied up in accounts receivable that you can't use for your own operations, which can strain your liquidity and working capital.
• Risk of late payment and bad debt: Not all customers pay on time, and some may not pay at all. If a buyer becomes insolvent or goes bankrupt, recovering what you're owed can be extremely difficult or even impossible. This protection against bad debt risk is one of the most significant downsides of offering credit.
• Administrative burden: Managing open accounts requires significant internal resources. You'll need to monitor payment schedules, chase late payments, maintain accurate records, and assess the creditworthiness of buyers before extending terms.

Good cash flow management is key to managing the risks that come with offering trade credit to your buyers. But there are other solutions that can help you protect your business and keep cash flowing smoothly.

Trade credit insurance and its cost

Trade credit insurance provides protection against non-payment from your buyers. If a customer doesn't pay their invoice on time, the insurer will compensate you for a percentage of the outstanding amount, helping you manage the financial impact of bad debt.

This type of coverage is flexible and can be tailored to suit your business needs. You can choose to insure all of your customer portfolio or just specific buyers, depending on your risk exposure. The insurer will also assess your customers' creditworthiness and provide you with credit limits for each buyer, which helps you make informed decisions about extending trade credit.

Beyond protection, trade credit insurance offers valuable insights into your customers' financial health. This means you can trade with confidence, knowing that you have support if a buyer becomes insolvent or delays payment beyond the agreed terms.

The cost of trade credit insurance is typically calculated as a percentage of your annual sales, usually a fraction of 1%. For example, a business with £2 million in annual sales might pay under £10,000 in premiums. To understand how much trade credit insurance costs for your business, you can use online calculators or speak to an insurance provider directly.

Other credit risk solutions

If you need to improve cash flow while waiting for buyers to pay, there are alternative credit risk solutions worth considering.

Invoice factoring involves selling your invoices to a third party (a factoring company) in exchange for immediate cash. The factoring company typically advances 70-90% of the invoice value upfront and pays the remaining balance (minus fees) once your customer settles the invoice. The factoring company will also manage collections on your behalf, though this means your customers will know you're using a factoring service.

Invoice discounting works similarly to factoring, but you retain control over your sales ledger and continue to manage customer relationships yourself. This option provides more confidentiality, as your buyers won't necessarily know you're using external financing.

Other options include selective invoice finance, where you choose which invoices to finance rather than committing your entire portfolio, and debtor-portfolio lending, which secures funds against your full portfolio of invoices without detailing each one individually.

Each solution has its own advantages and costs, so it's worth evaluating which approach best supports your business model and relationships with suppliers and buyers.

Get help avoiding bad debts and collecting customer payments

Use our free quote tool to see how much trade credit insurance will cost for your business.

Get your free quote