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Trade Credit 101: What is trade credit and why do I need to offer it?

Trade Credit 101: What is trade credit and why do I need to offer it?

Trade credit has been at the cornerstone of small business for as long as trade between businesses has existed. Some may even call it the greatest business facilitator of all time.

A recent report from Atradius revealed that as much as 60% of the total value of B2B sales in the UK are made using trade credit! The current climate has resulted in a dramatic spike, with many B2B businesses offering credit terms to generate more sales. In fact, 43% of businesses reported a third increase in the total value of sales made on credit since the onset of the coronavirus pandemic.

In this article, we take it back to basics and tell you everything you need to know about offering your business customers trade credit.

 

Trade credit explained

In a nutshell, trade credit is a B2B arrangement that allows business customers to purchase and receive stock, materials and equipment, or services whilst delaying payment. In other words, trade credit is a form of inter-company lending, which is the business version of “buy now, pay later”. 

Many of your customers will struggle with cash flow at some point or another and could find themselves in a difficult position when it comes to paying for their purchases. Solutions such as credit cards can come in handy, but they usually come with restrictive credit limits and create accounting headaches most of us can do without.

With trade credit, or “buy now, pay later”, you are offering your customers short-term, interest-free financing to buy the goods they need. You grant your customers 30, 60, or 90-day payment terms, or occasionally flexible instalments, and they get the goods or services without having to hand over any funds up-front. This can be especially helpful for customers who need time to sell on the goods that you’ve supplied since they can use the income to pay you.

If helping your customers stay out of the red is not enough to leave you warm and fuzzy… you also get to reap the rewards.

 

Why offer trade credit?

Offering your customers the opportunity to pay on credit terms (or buy now, pay later) can lead to a lengthy, mutually beneficial and profitable relationship. Here are just some of the benefits:

1-  It’s a great way to encourage sales 

Two thirds (65%) of businesses offering trade credit use it as a strategy to stimulate sales. Giving your customers the option to pay on credit terms ensures their cash flow is not disrupted and increases their profitability. What does this mean for you? It promotes recurring purchases and encourages buyers to spend more, resulting in an increase in revenues and average order values.

2- It helps you win new customers

Let’s face it, buyers like trade credit and the current environment only increases its attractiveness. Offering trade credit also sets you apart from the competition and lowers your customer acquisition costs. 24% of respondents in this Atradius survey said they granted credit to remain competitive.

3- It boosts customer loyalty

First things first, the fact that you trust your customers to pay you on terms will encourage loyalty. Additionally, providing your customers with the right, flexible payment options is key to providing them with a better shopping experience. Meaning, they are more likely to spend with you and less likely to look elsewhere. 

 

What about the risks and challenges of offering trade credit terms?

As with most things, offering trade credit to your business customers doesn’t come without its risks and challenges. Solutions to mitigate against these do exist, but you’ll need to know what you're getting into first. Here’s what you’ll need to keep front-of-mind:

1- Cash flow and financing

The most obvious one here is not getting paid immediately. As we mentioned earlier, by offering credit you’re essentially financing your customers. The money has to come from somewhere, and financing this off the back of your own balance sheet can leave a hole in your cash flow if you are not too careful. 

Thankfully there are a number of ways you can finance your debtor book, from getting credit from your bank, to invoice factoring companies.

2- Understanding your customers’ creditworthiness

Any establishment that decides to offer trade credit will need to run credit checks to understand if their customers are creditworthy. Afterall, extending credit is an act of trust. If your customers have a history of late payments or find themselves in poor financial health, you’ll need to know. 

Credit checking is a costly and time-consuming exercise. As a minimum, you’ll need to get access to credit history reports from the likes of Experian, Creditsafe or even using our Hokoscore, to make lending decisions.

3- Late payments 

The reality is, businesses don’t always pay on time. What’s more, the current climate has increased late payments. It’s reported that a whopping 47% of the total value of invoices are paid late. As it stands, over £23.4 billion is owed in outstanding invoices to UK businesses. 

Fortunately, credit checking your customers will weed out a large chunk of late payers. Some B2B merchants incentivise early payments by offering discounts to buyers that pay early. Whatever you choose to do, ensure you have an effective accounts receivable process to nip those overdue payments in the bud.

4- Non-payment

No matter what you do, there will be that one client who defaults on their payment - we’ve all seen it. Unlike late payments, unpaid invoices can be more challenging to handle - the customer may have gone out of business, or maybe they just can’t afford to pay. Either way, you’re left holding the bag (without the money!) 

In this case, a trade credit insurance policy protecting you against the risk of bad debt is the way to go.

5- Operational complexity

While this overlaps with points above, it deserves its own headline. Why? Because giving your customers the option to pay on credit can be an operational nightmare. You’ll need to ensure that you have got the right resources and processes in place to measure credit risk, handle invoicing and chase payments, detect any fraud, reconcile cash and so on… That means a lot of time and money. 

Luckily, we have a solution that streamlines the whole process, in one single integration (more on that below! 

 

The easy way to offer trade credit

Extending trade credit to your customers can benefit you by having a direct impact on your bottom line - your current customers will keep coming back to spend more, and you’ll get some new ones along the way. Winning!

Hokodo’s Trade Credit as a Service solution can help B2B merchants and marketplaces provide their customers with transparent and flexible payment terms, without any of the risk (or faff). Our solution simplifies and streamlines the whole process - we take on the risk and hassle of credit checks, chasing unpaid invoices, and credit insurance against non-payment. You can even choose to get paid instantly, leaving you to focus on what matters the most - your business’ success.

Offering trade credit is just one part of the B2B payments stack. Providing your customers with a purchasing experience fit for today is another - we’ll discuss this in upcoming blogs.

In the meantime, book a demo to find out more about increasing your bottom line and offering trade credit to your customers here.