Trade Credit

Supplier Terms as Working Capital

Every day of supplier credit reduces the cash your business must fund itself. A company that buys $60,000 of materials a month on net 30, rather than paying on delivery, is in effect carrying about $60,000 of supplier financing at any time. Move to net 45 and that figure rises to about $90,000.

This shows up in the cash conversion cycle as days payables outstanding. Longer supplier terms shorten the cycle and reduce how much you need to borrow from banks or other lenders.

Risks of Leaning Too Hard on Suppliers

• Credit holds. Late payments can lead a supplier to stop shipping or move you back to cash on delivery at the worst possible moment.

• Lost discounts and late fees. Many invoices carry late charges, and missed discounts add up over a year.

• Lien rights. In construction, unpaid suppliers may have mechanics' lien rights against the project, which can strain your relationships with owners and general contractors.

• Weaker bargaining position. A customer known for slow payment tends to get less favorable pricing and terms.

How Lenders View Your Payables

Lenders review your accounts payable aging alongside your receivables. Payables that are mostly current suggest good cash management. A growing share more than 60 or 90 days past due suggests the business is using suppliers as an unplanned source of financing, which raises concern.

Some owners use a working capital loan or line of credit specifically to pay suppliers on time or capture early-payment discounts. Lenders often see that as a sound use, because it strengthens supplier relationships and can lower overall costs.

Frequently Asked Questions

Is trade credit a loan?
Not in the formal sense. There is usually no interest charge or loan agreement, just invoice terms. It does appear on your balance sheet as accounts payable, a current liability.

How can a new business get supplier terms?
Start with suppliers that work with small accounts, provide references and bank information, pay promptly on early orders, and ask for terms after a few months of reliable payment.

What if I am the seller offering terms?
Offering terms can win customers but ties up your cash in receivables. Check customer credit, set limits, and consider receivables financing or credit insurance if receivables grow faster than your cash can support.

Do late payments to suppliers affect my business credit?
They can, if the supplier reports to a business credit bureau or sends a past-due account to collections.

Finance Your Purchases Wisely

Supplier terms work best as one part of a broader funding plan. If your purchases are growing faster than your cash, compare lines of credit, inventory financing and other working capital options that let you pay suppliers on time and keep your trade credit strong.

Trade credit is the short-term financing suppliers give their business customers when they deliver goods or services now and accept payment later. Terms such as net 30 are so common that many owners do not think of them as financing at all, yet an open account with a supplier works much like an interest-free loan for the length of the terms.

This guide explains common payment terms, how to work out the real cost of an early-payment discount, how suppliers decide whom to offer terms to, and how lenders look at the payables on your balance sheet.

How Supplier Payment Terms Work

• Net 30, net 45, net 60. The full invoice amount is due within that many days of the invoice date.

• 2/10 net 30. Take a 2% discount if you pay within 10 days. Otherwise, pay the full amount within 30 days.

• End of month. The payment period starts at the end of the month in which the invoice is dated, which groups many purchases under one due date.

• Cash on delivery. Payment is due when goods arrive, common for new customers without a payment record.

• Cash in advance. Payment before the supplier ships, usually for custom orders or customers the supplier sees as high risk.

Terms are negotiable. A supplier may start a new account on cash on delivery and move it to net 30 after several months of reliable payments.

The Real Cost of Skipping an Early-Payment Discount

Passing up a discount is a form of borrowing. Under 2/10 net 30, paying on day 30 instead of day 10 lets you keep the money 20 extra days in exchange for giving up 2% of the invoice. On an annual basis, that is expensive.

A standard approximation is the discount percentage divided by 100 minus the discount percentage, multiplied by 365 divided by the number of extra days.

• 2/10 net 30: 2 divided by 98 is about 2.04%. Multiply by 365 divided by 20, which is 18.25, and the result is about 37.2% a year.

• 1/10 net 30: 1 divided by 99 is about 1.01%. Multiply by 18.25 and the result is about 18.4% a year.

If you can borrow on a line of credit at a lower annual rate than that, it can pay to draw on the line and take the discount. Run the numbers using your own terms and borrowing costs.

How Suppliers Decide Whether to Extend Credit

A supplier that offers terms takes the risk that you will not pay. Before opening an account, it may:

• Ask for a credit application with business details, bank information and trade references

• Contact your references to ask how promptly you pay

• Check business credit reports and public records such as liens and judgments

• Request financial statements for larger accounts

• Require a personal guarantee from the owner, especially for newer businesses

The supplier then sets a credit limit, the largest balance you can carry at one time, and reviews it as the relationship develops.

Building a Strong Payment Record

Your history with suppliers becomes part of your business credit profile. Some suppliers report payment data to business credit bureaus, and lenders and new suppliers often check those reports.

• Pay on or before the due date. Consistent on-time payment matters more than the size of the account.

• Ask who reports. Find out whether a supplier reports payment history before you count on that account to build credit.

• Keep your details consistent. Use the same legal name, address and tax ID on every account so reports match up.

• Call early. If a payment will be late, contact the supplier before the due date and agree on a plan.