Trade credit is a means by which a business can purchase goods on account, laying out nothing up front but agreeing to pay the supplier at a later date. It is an “absolutely essential component” of the operating capital structure for both startup and growing businesses, says Jonathan B. Smith, founder and CEO of consulting firm ChiefOptimizer, and it is often the first extension of credit from a third-party source that is made accessible to a young business.
About 60 percent of U.S. small businesses use trade credit, according to The Oxford Handbook of Entrepreneurial Finance; the only other financial service with greater penetration in this market is checking accounts. However, trade credit remains an important capital management tool even as companies grow and expand. It is one of the most important sources of borrowing among all types of firms and throughout different economies. A 2008 survey covering businesses of all sizes in 48 countries found that an average of almost 20 percent of all investment financed through external sources was done using trade credit.
Trade credit terms are often expressed in a numeric format, such as “2/10/30” or “2/10, Net 30.” The first two numbers refer to the discount offered by the supplier for early payment, the last to when the entire outstanding balance must be paid. For example, if you purchase goods or services worth $5,000 on trade credit terms of 2/10/30, you qualify for a discount of $100 (2 percent of $5,000) if you pay within 10 days, but you must pay the entire balance within 30 days no matter what.
Viewed in isolation, a $100 discount may not seem very significant, but if you place that $5,000 order every month, it adds up to $1,200 over the course of a year. Since that savings flows straight through to the bottom line, it’s the equivalent of $1,200 in additional profit. A business working on a 20 percent profit margin would have to book an additional $6,000 in sales to match that performance. What’s more, by taking advantage of trade credit offers from suppliers, early-stage ventures can establish a history of repayment that may make it easier for them to secure bank financing as they continue to grow.
Startups and early-stage businesses can make themselves more attractive candidates for trade credit from vendors by being able to show a good personal credit history and a well-developed business plan detailing monthly revenue targets and anticipated cash flows sufficient to service trade credit debt, says Joel S. Mutnick, CPA, director of audit at accounting firm Fiske & Company. Growth businesses and those in later stages of maturity should stress their track record of success and their ability to adapt to changes in the marketplace.
The first thing any business should do to make it a better candidate for trade credit is “get on the map” by becoming listed with credit rating agency Dunn & Bradstreet and getting a D-U-N-S number, suggests Meredith Wood, director of community relations at Funding Gates, a developer of accounts receivable software. “Open a credit card under the business name, and start using it and paying off the balance right away,” she says. “Find other ways to show your business pays on time by opening up accounts with larger brand names, since they tend to report to the credit bureaus. Be willing to negotiate with vendors to prove you’re a good payer.”
Article provided by Inc. © Inc.