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What is Trade Credit?
Trade Credit is allowing a customer to charge the purchase of an item to an in house account. You, the business owner, are essentially acting as the bank or financing party…but are not actually collecting any interest so long as it is paid within the stated period of time. Typical terms are 10 days or 30 days which is stated as net/10 or net/30. If you offer discounts for earlier payment your terms may be stated as 10/2, net/30 which means that you will give a 2% discount if paid within 10 days, otherwise full payment is due in 30 days. Trade credit is a necessary cost in most industries that are primarily Business to Business (B2B) sales. It would not be reasonable to make another business drive over and pay cash or mail a check before you ship a product…therefore trade credit supports the free flow of commerce.
Why Offer Trade Credit?
Historically, trade credit has been offered for many reasons. Most of the time it is offered because your competitors offer it and you must in order to stay competitive. Sometimes it is necessary due to the industry and/or the nature of the business. Still other times it is not required but credit is offered to increase sales, increase the size of each sale, broaden your customer base and augment customer service or marketing activities. For the last set of reasons credit should not be issued lightly. You need to ask yourself:
· What should be my billing terms?
· Who will facilitate the collection of outstanding accounts?
· How will I handle delinquent accounts?
· Should I require deposits?
· Will I require a contract?
· How will I screen customers for playability?
· Can I afford to extend credit?
You can expect a large number of payments to come in late and some that will not come in at all. You will need to set up a process for estimating bad debts and limiting your losses to those that you can afford to take.
The True Cost of Credit
Understanding the true cost of credit will help you answer the last question raised in the above list. You can only afford to offer credit if the increase in collectable sales is greater than the additional cost of extending that credit. These costs include both the cost of the funds needed to cover the items sold until payment is collected and the cost of collecting payment once it has been extended. These are very real costs as extending credit not only increases the Cash to Cash Cycle which translates into additional interest expense or the opportunity cost of other investments if your cash on hand is not financed.
Screening applicants is crucial to successfully implementing a trade credit policy. At a minimum the information you collect about applicants should include:
· A credit report
· Commercial or personal references given by customer
· Telephone directory (verify address)
· Personal identification (charge plates, driver’s license, passes)
· A list of approved employees who can charge to the account
Some additional costs of processing credit include setting up a system to bill, track and collect payments. Slow-paying accounts or accounts who pay outside of the terms using strong arm tactics. This customers are typically your larger (largest) buyer who set their own terms or pay at 30 days but pay the discounted price. In addition, there is the time that could be used to make more sales through other methods and the cost loosing customers because of denial of credit.
Outsourcing Your Credit
All in all extending and managing credit is a monumental task that is often better left to people who do it for a living. The convenience of credit cards has made trade credit an unnecessary thing of the past for all businesses except those in B2B sales or where it is commonplace in the industry. Accepting credit cards can give you many of the same benefits of trade credit with out the hassle of collection. By accepting credit cards you can:
1. Increase the number of customers who will buy from you. Some customers won’t use cash and don’t carry a check book. Others like the ability to buy now- pay later.
2. Helps Build a mailing list by collect addresses from card holders to use for direct mailing. Your current customers are provide the highest return on your advertising dollar.
3. Elimination of time, effort, and risk or extending your own credit. No screening, verification, or approval process. No billing, waiting for payment or bad debts.
Credit Cards offer the convenience of multiple payment methods to increases sales and profits by 30 -100% or more (according to Visa International). Advertising that you accept credit and debit cards increases your credibility. The public knows that Merchant Account status is not always easy to get and will look at you as more of a solid company - here to stay. Customers are also more likely to make larger purchases, upgrade to a more expensive model and buy on impulse when using a credit card.
In order to accept credit cards you need to apply for a merchant account. Be careful about entering into an Agreement with an Acquirer based on price alone. Many Acquirers will offer a “great deal" on software or hardware only to make it up on rates and fees later. Look for a company that does not use these type of "bait and switch" tactics.
Summary
Selective and sensible use of credit can help to build a business. The right tools, properly used, can guide this process and increase profits but determine if you truly need to offer credit and if the benefit outweighs the total costs in the long run before you make that decision. Finally, outsourcing your credit can offer many of the same benefits without the drawbacks of extending trade credit.
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