by Heather Smart Johnson
Trade Credit Insurance Explained
Has your company ever paid for goods or services with a purchase order? If so, then you have used trade credit. Trade credit is the ability for a business to get goods or services from another business without paying immediately. Different industries have different variations of trade credit, but the underlying principle is the same. Trade credit is an alternative to prepayment or cash on delivery. Trade credit allows the receiving business time to come up with the money to pay for goods or services, often from the sale of the goods or use of the services provided.
Advantages of Trade Credit
Trade credit can help you grow your business. When a business is able to purchase goods or services with trade credit, it frees up cash flow, making it a source of short-term financing. This practice allows the business to potentially expand its market or customer base without the negative impact of running out of cash, potentially putting them out of business. Many trade credit agreements incentivize paying early with a discount, so the business is able to decide whether to pay early at a cheaper price or to take longer to pay at full price — based on both money coming into the business and other expenses that need to be paid.
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Net What?
Trade credit agreements come with terms like Net 60, Net 30, Net 15, or Net 10. In this case, “net” refers to the total amount due after any discounts and the number refers to the number of days until the payment is due. For instance, “Net 10” means that payment is due within 10 days of the goods being sent or services being completed. Transit time is included in the number of days, meaning the number of days starts on the day the goods are shipped, and interest penalties begin on the next calendar day — so using our “Net 10” example, interest penalties would begin on day 11. Companies offering trade credit often offer a discount for paying a Net 60 or Net 30 invoice early.
Other Credit Terms
In addition to the agreed-upon timeframe for payment, a monetary limit is usually set. Credit terms will differ from business to business and industry to industry, often related to how quickly the business is able to receive payment from its customers, making it able to repay its suppliers. Businesses need longer net terms with their suppliers than those they offer their customers or additional funding will be needed.
Disadvantages of Trade Credit
As a distributor of goods or services, it is important to know which businesses you can trust to pay you. Account receivables are arguably a company’s most important and underestimated asset. Trade credit includes an inherent risk that your company might not get paid. A business may take your offer of trade credit, but then through mismanagement of their investments or other lack of cash flow, become unable to pay. Trade credit does enable you to see potential problems developing and take steps, such as changing the amount of credit offered or the net terms of how long you are willing to wait to be paid. But what do you do if the business doesn’t pay? Trade credit insurance may protect you from money owed to your company due to protracted default, insolvency, or bankruptcy of businesses that you have already provided goods or services to.
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