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Trade Credit Management: A Short Guide

man at computer considering trade credit

Trade credit is an important aspect of how businesses operate. It simply means that when a business sells products or services, it gives the buyer a period of time to pay the amount. Let’s take a closer look at how trade credit works, the benefits and challenges it raises, and how it can be managed.

A quick overview

‘Trade terms’, also called ‘invoice payment terms‘, is another way to express the concept of trade credit and applies to business-to-business transactions. When it’s used, the purchaser of goods and services receives an invoice that should be paid within the agreed time period. In effect, it’s like a short-term business loan that is granted to  the buyer from the seller. 

The payment period is often 30 days, but can be any agreed period such as 7, 15 or even 60 days to pay. In accounting language, this is expressed as ‘net 7’, ‘net 15’, ‘net 30’ or ‘net 60’. Some businesses offer discounts for early payment. For example, when a company offers 30-day payment terms and a 5 per cent discount if the invoice is paid within 10 days, this is expressed as ‘5/10, net 30’.

In addition to agreeing upon the payment period as part of the credit terms, sellers will also set credit limits based on the perceived trade credit risk of the customer. The credit limit can be raised over time if the customer shows a track record of paying invoices on time.

Benefits of offering trade credit

If you sell to other businesses, offering payment terms facilitates transactions between you and your customers. Instead of having to pay immediately for something or paying in advance, the buyer gets the flexibility to pay in the future. This makes it easier for many small businesses, especially if they don’t have full-time bookkeeping staff. In many cases, businesses have certain times each month when they pay the invoices they owe and trade credit makes this possible. 

Trade credit is also offered because it’s a common practice in business-to-business markets. A survey conducted by Moula Pay revealed that 47 per cent of SMEs offer trade credit because customers expect it. In addition, when asked why they offered trade credit:

  • 34 per cent said it’s an important selling point 
  • 30 per cent said because their competitors do
  • 21 per cent said it enables them to sell more.

From the customer perspective, invoice payment terms help to improve working capital – 67 per cent of SME owners said that invoice payment terms help to improve their cash flow.

Shortcomings of trade credit

Despite the many benefits of offering invoice payment terms, there can be a large cost. For sellers, getting paid later for products and services hurts cash flow. The Moula Pay research showed that:

  • 63 per cent of SMEs said cash flow is negatively affected by late payments
  • 65 per cent of SME customers don’t pay on time
  • Almost 40% of SME customers pay later than 30 days.

In addition to the cash flow impacts, there is the expense of managing accounts receivable and chasing outstanding debt. The credit management process includes vetting new customers to determine if they are creditworthy. 

If the risk management is not effective and some customers don’t pay, the business can hire a collections agency to follow up on unpaid invoices in an attempt to avoid bad debts. Most collections agencies work on a commission basis, charging between 10 and 30 per cent for the value of debts collected.

Managing risk with trade credit insurance

One option for managing the risk of offering invoice payment terms, is trade credit insurance, also known as debtor insurance and accounts receivable insurance. Trade credit insurance protects your business if customers don’t pay their invoices. This insurance is also for international trade and protects against risk of not being paid when export credit is granted to customers.

An new alternative to offering trade credit

If your business sells to other businesses, you probably experience some of the shortcomings mentioned above. Even if you are effective at managing accounts receivable, you probably still have late-paying customers who negatively affect your cash flow. In addition, accounts receivable management requires resources in the form of time and money. 

Moula Pay was created to help businesses overcome the shortcomings of offering trade credit and creates a win-win situation for buyers and sellers. 

Moula Pay is a smarter way to offer your business customers payment terms. When your customers pay with Moula Pay, you get paid upfront. Your customers enjoy up to 12 months to pay, with the first 3 months interest and repayment-free.

Become a Merchant today to:

  • Get paid upfront: Give your customers great payment terms that improve your cash flow
  • Stop chasing payment: Outsource the pain of chasing receivables, and let Moula take the risk of unpaid invoices
  • Sell more, more often: Providing your customers with access to more funds means they can spend more with you

Learn more about how Moula Pay can give your customers great payment terms, and save you chasing invoices.

Author:

All the thoughts, ideas and musings from the Moula team! Covering everything from work/life balance to general finance tips plus everything in between!

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