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

Fatima Ayoub
Head of Marketing

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, but exactly what is trade credit? And why is it so essential for modern B2B e-commerce?

According to the World Trade Organisation, around 80-90% of world trade relies on trade credit, and a recent report from Atradius revealed that as much as 60% of the total value of B2B sales in the UK are made on such payment terms.

Ongoing economic impacts of the pandemic have resulted in a dramatic spike in the adoption of trade credit, with many B2B merchants and marketplaces 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 terms since the onset of the coronavirus pandemic.

Clearly, trade credit is a key tool for B2B commerce, but for many merchants and marketplace owners it is still something of a mystery. In this article, we take it back to basics and tell you everything you need to know about offering trade credit to your business customers.

Here’s what we’ll be covering:

 

What is trade credit?

In a nutshell, trade credit is a B2B arrangement that allows business customers to purchase and receive stock, materials, equipment or services whilst delaying payment. In other words, trade credit can be defined as a form of inter-company lending or, put simply, 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 needed to run their business without having to hand over any funds upfront. This can be especially helpful for customers who need time to sell on the goods that you’ve supplied since they can then use the income to pay you.

 

Trade credit advantages and disadvantages

If helping your customers stay out of the red is not enough to leave you feeling warm and fuzzy inside, you also get to reap a range of rewards when you offer trade credit to your customers. However, there are also a number of risks which you’ll need to consider. Find out about both sides of the argument below.

Trade credit advantages

‍‍‍Offering your customers the opportunity to buy now, pay later can lead to a lengthy, mutually beneficial and profitable relationship. Below 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 tough economic climate only increases its attractiveness. Offering trade credit also sets you apart from the competition and lowers your customer acquisition costs. All else being equal, if you’re selling the same product as a direct competitor, you increase your chances of winning the deal if you offer longer payment terms. 24% of respondents in this Atradius survey said the main reason they grant credit is to remain competitive.

3. It boosts customer loyalty

First things first, the fact that you trust your customers to pay later will encourage loyalty. Additionally, providing your customers with convenient and flexible payment options is key to providing them with a better shopping experience, meaning they are more likely to spend with you instead of your competitors.

Trade credit disadvantages

Offering trade credit to your business customers doesn’t come without its risks and challenges. Trade credit management solutions designed to mitigate risks are available, but you’ll need to know what you're getting into first. Here’s what you’ll need to keep in mind.

1. Cash flow and financing

Perhaps the most obvious risks of offering trade credit stem from 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, you could consider:

  • Getting credit from your bank
  • Engaging an invoice factoring company
  • Partnering with a B2B Buy Now, Pay Later provider like Hokodo

Find out what you should be looking for in a B2B Buy Now, Pay Later provider in our 5-part blog series.

2. Understanding your customers’ creditworthiness

Any merchant or marketplace that decides to offer trade credit will need to run eligibility checks to find out if their customers are creditworthy. After all, 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. At a minimum, you’ll need to get access to credit history reports from the likes of Experian or Creditsafe, or use our Hokoscore tool, to inform your lending decisions.

3. Late payments 

The reality is, businesses don’t always pay on time. What’s more is that the economic impact of the pandemic has increased the number of businesses making 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 ahead of schedule. 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 to protect your business against risk, there will be that one client who defaults on their payment. 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 could protect you against the risk of bad debt.

5. Operational complexity

While operational complexity overlaps with some of the points above, we think it deserves its own headline. Why? Because giving your customers the option to pay on credit has the potential to be an operational nightmare. You’ll need to ensure that you have 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 often means a lot of time, money and resources which might be better spent elsewhere. 

Fortunately, we have developed a B2B Buy Now, Pay Later solution that streamlines the whole process of offering trade credit to your online customers, but more on that later.

 

Why you need to offer trade credit

73% of B2B buyers are millennials who prefer to buy online. Having grown up during the age of Amazon, ASOS and slick consumer e-commerce, they have high expectations of how online trade should look and feel. If these buyers want to pay on credit terms – which they often do – they’re expecting an instant, frictionless solution comparable to Klarna; not a 4-page form and a 3-day wait.

Meanwhile, 97% of all business buyers say they will make a purchase in an end-to-end, digital self-serve model, with the vast majority comfortable spending $50,000 or more online. If you don’t have the right payment options integrated into your online checkout, you’re effectively handing these transactions over to the competition.

As you can see, offering seamless trade credit is no longer a nice-to-have but an absolute essential in B2B commerce, offline and online. Hokodo can help your business to make it a reality.

 

The easy way to offer trade credit online

Extending trade credit to your customers can benefit your business by having a direct impact on key metrics like conversion rate, average order value and purchase frequency. Your current customers will keep coming back to spend more, and you’ll gain some new ones along the way. 

Hokodo’s Buy Now, Pay Later solution can help B2B merchants and marketplaces provide their customers with transparent and flexible payment terms, without having to take on 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 more time, cash and resources to focus on what matters the most – the success of your business.

Book a demo to find out more about how Hokodo can help you to reap the rewards of offering a modern trade credit solution.