Trade credit financing allows two businesses, a customer and a supplier, to purchase goods or services using a short-term financing agreement instead of paying cash upfront. This allows the customer to obtain goods and pay for them later, usually anywhere from 7 to 120 days. This form of financing is commonly used by B2B companies and can allow flexibility for cash flow management and business credit.
Key takeaways:
- Trade credit is also known as “vendor credit” or “net terms.”
- It acts as a more informal financing arrangement than a standard business loan.
- It offers delayed payments for cash flow management, allowing customers to access goods and services first and pay for them later, and can even build customers’ business credit.
How trade credit works
Rather than approaching a lender to finance products or services, trade credit is an arrangement between a customer and a supplier. The supplier provides goods or services, and the customer pays for them at a later date.
Generally, terms are anywhere from 7, 30, 60, 90, or 120 days and commonly referred to as “net plus number of days” (e.g., net 60). Essentially, this means that the payment terms allow for 60 days to pay for the goods or services issued by the supplier.
Trade credit is often considered to be a form of interest-free financing, although fees or penalties may be incurred if you don’t pay on time or as agreed. Trade credit payments are often reported to commercial credit bureaus, like Dun & Bradstreet, Experian Business, and Equifax Business.
Trade credit example
I’ll walk you through a practical example of how trade credit works in a business-to-business transaction.
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- You place an order with a vendor. You run a small landscaping business and need to purchase 500 bags of mulch from a wholesale supplier. The supplier charges $4.00 per bag, bringing the total order to $2,000.
- The supplier extends trade credit. Instead of requiring immediate payment, the supplier offers you trade credit with terms of 3/15, net 45. This means you’ll receive a 3% discount if you pay within 15 days; otherwise, the full amount is due within 45 days.
- You receive an invoice. The supplier ships the mulch and sends an invoice listing the $2,000 balance, along with the payment terms and a late fee policy of $25 for each day payment is overdue beyond the 45-day window.
- You choose when to pay. If you pay within 15 days, you’ll receive a 3% discount, reducing your total payment to $1,940. If you wait until the 45th day, you’ll owe the full $2,000. However, if you pay late, e.g., on the 50th day, you’ll also be charged a $125 late fee ($25 Ă— 5 days), bringing your total to $2,125.
Common types of trade credit
Trade credit can have many forms. Common types include the following:
- Open account is the most common and informal type, where the supplier delivers goods or services and issues an invoice with payment terms (such as net 30 or net 60). No signed agreement is required.
- Promissory note is a written agreement in which the buyer accepts the payment terms, including the due date, and signs the document before sending it back to the seller. This type is more formal and may be used for larger transactions or when the seller wants added security.
- Bills payable are financial documents issued by the seller and formally accepted by the buyer, who agrees to pay the specified amount by the agreed-upon due date. This is often used in international or high-value transactions.
Pros & cons of trade credit
Who uses trade credit
A supplier or vendor offers trade credit, and customers or buyers are the ones who use it for their business. It is usually an arrangement between B2B companies and is used by a wide range of industries. It’s particularly useful for wholesale, manufacturing, or other business types requiring ample inventory.
Some examples of this might include the following:
- A retailer might use trade credit to stock seasonal inventory without paying upfront, allowing them to generate revenue before the invoice is due.
- A construction company could purchase materials or equipment on net 60 terms to complete a job and get paid before paying the supplier.
- A restaurant may rely on trade credit from food distributors to manage cash flow and maintain inventory.
When to use trade credit
Trade credit is best suited for short-term business needs, especially when you
- Need to restock inventory before you receive customer payments
- Want to preserve cash flow during slow seasons
- Are building a track record with vendors to strengthen business credit
It may be unideal for long-term purchases, major expansions, or when early payment discounts are too valuable to pass up.
Our related resources:
Getting trade credit
If you’re looking into trade credit and wondering how to go about obtaining it, there are a few options. Mainly, you’ll want to
- Approach the suppliers or vendors you’re interested in and learn about their options
- Factor in whether you meet their specific qualifications, which can vary vastly
Even though it might not require a formal underwriting process like a traditional business loan, the supplier will likely still want to see your creditworthiness as a borrower to ensure that it gets paid.
Commonly reviewed items
- Credit score: Your business credit score will likely be taken into account so that the supplier can evaluate your overall creditworthiness.
- Business size and industry: Some suppliers may factor in your business size or industry to determine how much stock you’ll need or your plans for growth.
- Business finances: Your business financial statements may be requested by the supplier so that it can determine whether your business’s cash flow and profitability are enough to be able to repay the goods or services issued.
- Payment history: Your overall payment history may be considered, as it shows how likely you are to pay on time and as agreed.
- Trade references: These are typically part of your business credit report, and suppliers might refer to your past trade references to ensure you pay on time and have no penalties.
Those items will also potentially impact the terms the supplier offers you. The better your qualifications, the more likely you are to secure more favorable financing terms, including longer repayment periods and the amount of goods or services.
How to apply for trade credit
If you decide to pursue applying for trade credit, there are a few steps involved. Generally, this is how to proceed:
- Step 1: Identify suppliers. Start with vendors you already work with or ones that serve your industry.
- Step 2: Ask about terms. Inquire whether they offer net terms or other forms of trade credit.
- Step 3: Complete a credit application. Be ready to share your business details, EIN, time in business, and trade references.
- Step 4: Submit financial documents. Supply the requested documents, such as cash flow statements, income statements, or tax returns.
- Step 5: Start with a small order. Do this because if you’re new, the vendor may grant a lower credit limit until you prove that you’re reliable.
- Step 6: Pay invoices on time. Remember that this not only protects your relationship but also helps you qualify for higher limits or better terms over time.
When issuing trade credit, suppliers will typically extend an invoice as evidence of the agreement. Others may ask for something a bit more formal, such as a promissory note. That way, the supplier is legally protected in the event that you don’t make payments.
Where to get trade credit
The most common way to access trade credit is directly through your suppliers. Many vendors offer net payment terms — such as net 30 or net 60 — to established business customers.
To start, reach out to suppliers you already work with and ask if they offer payment terms on future purchases. Be prepared to complete a credit application and provide basic details about your business, such as time in operation, annual revenue, and trade references.
If you’re working with a new vendor, you may need to build trust with smaller, prepaid orders before qualifying for trade credit.
How to manage trade credit
To maintain good standing with your supplier, pay close attention to the terms and conditions of your agreement.
- Track due dates carefully. Use accounting software or calendar reminders to avoid late fees.
- Take advantage of early payment discounts when possible. These can add up to significant savings.
- Avoid overreliance. Using too much trade credit can lead to potential cash flow problems and put strain on vendor relationships.
- Communicate with vendors. If you’re running into delays, keeping your supplier informed can prevent penalties or strained relationships.
Alternatives to trade credit
If trade credit is unavailable to you or you need financing for other business purposes, here are some alternative funding options.
- Term loan: This is a solid option if you’re planning a major business investment, such as opening a new location or renovating your current space. Term loans typically offer larger loan amounts and repayment periods ranging from 3 to 10 years. If you’re considering this route, take a look at our top-recommended small business loans.
- Equipment financing: If you need to purchase or upgrade tools, vehicles, or machinery, equipment financing may be a better fit. These loans are secured by the equipment itself, which often makes approval easier, especially for borrowers with fair or limited credit. To get started, check out our lists of the top equipment financing companies and best equipment leasing companies.
- Business line of credit: For flexible, recurring access to capital, a business line of credit allows you to draw funds as needed and only pay interest on what you use. This is especially helpful for covering short-term expenses or managing cash flow. Learn more in our guides to getting a small business credit line and the leading small business lines of credit.
- Microloans: If you are just starting out or only need a small amount of funding, a microloan could be a practical alternative. These loans, often offered through nonprofit lenders or the SBA microloan program, tend to have more lenient requirements.
Frequently asked questions (FAQs)
Trade credit allows businesses to buy goods or services now and pay later, helping improve cash flow without the need for loans or interest charges. It’s a simple way to access short-term financing, build relationships with suppliers, and strengthen your business credit, all while keeping more cash on hand to cover other expenses or invest in growth.
Trade credit usually doesn’t cost anything if you pay on time, making it a low-risk way to manage cash flow. However, late payments can lead to fees or strained supplier relationships, and skipping early payment discounts may mean missing out on potential savings.
No, trade credit differs from traditional business loans. However, it is a form of financing that functions similarly to one. It’s an informal agreement where a supplier lets you buy goods or services now and pay later, often within 30 to 60 days. There’s no interest if you pay on time, and it doesn’t require a formal lending process or collateral like a bank loan would.
Trade credit is a simple agreement where a supplier lets a buyer pay later, usually within 30 to 90 days, with no interest if paid on time. Trade finance, on the other hand, involves third parties, like banks or lenders, that help fund or guarantee transactions, especially in international trade.
