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Trade Credit

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Glossary of Important Financial Terms You Should Understand

Trade credit is the credit extended to you by suppliers who let you buy now and pay later. Any time you take delivery of supplies, equipment, and services without paying cash on the spot, you are using trade credit. Trade credit is the largest use of capital for many business-to-business sellers in the United States, and is an important source of capital for a majority of all businesses. Data from the Federal Reserve Board’s Surveys of Small Business Finances indicates that about one- third of all small-business debt is in the form of trade credit, about the same portion as is obtained from commercial banks.

Suppliers are often willing to sell on credit so that they can gain more customers and profitable sales. New and small business customers may be offered a relatively small amount that they can buy on credit until they prove they will can be trusted to repay the obligation per agreements. Suppliers may require small business owners to guarantee trade credit obligations of their business, but seldom require collateral to secure repayment of obligations. As a supplier gains trust they often will offer more generous repayment terms and credit amounts.

Trade credit terms typically require repayment in 10 to 30 days. Sometimes suppliers offer a discount (often 1% to 2%) if the balance is paid within a specified number of days to encourage prompt payment. If payments are made after the due date there can be significant late fees, the supplier my revoke trade credit or increase prices, and even quit selling to the customer.

For businesses that keep their repayment commitments to suppliers, trade credit is almost a free source of capital with which to finance their business. If the privilege is abused it can be one of the costliest sources of capital.

Trade Credit

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