No bank is involved and there is usually no interest, as long as the customer pays by the due date. The cost sits elsewhere, in the price, in any early payment discount the buyer gives up and in the cash the seller waits for. In most sectors it is simply how businesses buy from each other, because few customers pay for goods before they arrive.
How trade credit works
- The customer applies. It completes a credit application with its company details, references and the credit it wants.
- The supplier decides. After a credit check it sets payment terms, such as net 30, and a credit limit.
- Goods or services are delivered and invoiced. The invoice shows the terms and the due date.
- The customer pays by the due date. If it does not, the supplier reminds, escalates and may stop further deliveries until the account is paid.
Trade credit from both sides
| Point | Seller | Buyer |
|---|---|---|
| On the balance sheet | An asset, accounts receivable | A liability, accounts payable |
| Speed measure | Days sales outstanding | Days payable outstanding |
| What it costs | Cash tied up until payment, plus the risk of bad debt | Usually nothing before the due date, apart from any discount given up |
| Main risk | The customer pays late or not at all | Losing credit terms or supply after paying late |
What trade credit costs
For the buyer, trade credit is free up to the due date unless it means giving up a discount. On 2/10 net 30, keeping the money for 20 more days instead of taking 2% off costs about 37% a year, as the early payment discount entry shows.
For the seller, the cost is funding the receivables until customers pay.
Example. A supplier sells £600,000 a year on 30-day terms, about £1,644 a day. If customers pay on day 45 on average, it carries 45 days of sales, about £73,970, in receivables. At an illustrative borrowing cost of 8% a year, that costs about £5,920 a year before any bad debts. If customers paid on day 30, receivables would be about £49,320 and the cost about £3,950. All figures are illustrative.
Trade credit vs a bank loan
Trade credit needs no separate application to a bank, rarely needs security and costs no interest when the invoice is paid on time. It is tied to purchases, so it grows with orders and disappears if the supplier stops supplying. A bank loan or overdraft can be used for anything, but it has to be arranged, priced and usually secured in advance. Lenders look at both, because a business that pays suppliers later and later is often short of cash.
How to manage trade credit risk
- Check before you lend. Look at the customer's filed accounts, for example on Companies House in the UK, a credit report and what other suppliers say about how it pays.
- Cap the exposure. Set a credit limit and review it when the customer's payments slow down or its orders grow.
- Keep title to the goods. A retention of title clause agreed before the sale can let you take back unpaid goods the customer still holds if it becomes insolvent, as long as they can be identified.
- Insure the receivables. Trade credit insurance pays a share of the loss, usually 75% to 95%, when an insured customer does not pay.
- Take security for bigger risks. Ask for a deposit, a parent company or personal guarantee, or a letter of credit.
- Chase from the start. Remind customers before the due date and follow up as soon as an invoice is late, because old debts are harder to collect.
The law also limits how long trade credit can run between businesses. In the UK, agreed terms should usually be no longer than 60 days, and the EU Late Payment Directive limits them to 60 days unless expressly agreed and not grossly unfair to the creditor. A supplier paid late can claim statutory interest and late payment compensation.
Sunbay handles the collection side of trade credit. It connects to your ERP or accounting system, reminds customers by email and SMS before and after the due date, issues interest notes and payment demands and shows open and overdue balances for each customer. See every invoice and payment in one place.
Frequently asked questions
Is trade credit a loan?
Not in the legal sense. No money changes hands at the start, because the supplier simply delivers before it is paid. In economic terms it works like a short interest-free loan, as long as the buyer pays on time.
Is trade credit an asset or a liability?
Both, depending on the side. The seller records it as accounts receivable, a current asset, and the buyer as accounts payable, a current liability.
What is an example of trade credit?
A wholesaler delivers £20,000 of stock to a retailer on net 30 terms. The retailer sells part of the stock and pays the invoice within 30 days, so the wholesaler has financed the retailer for a month.
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