Trade Credit: Payment Term Options for Small Businesses
December 28, 2020 | Last Updated on: March 3, 2023
December 28, 2020 | Last Updated on: March 3, 2023
As we enter the new year, contracts may be up for negotiation and it is important to figure out what terms work for your business in this pandemic economy. Determining what trade credit works best for your business plan – as either a supplier or vendor – is integral to ensuring receivables and payments are not past due.
Many small businesses are figuring out how to pay suppliers and sell to new vendors, both as businesses are reopening and e-commerce is picking up. But invoicing and due dates may be new terms, so we wanted to walk through the basics of trade credit, including the options for Net-30, that allow buyers extended periods of time to pay for a purchase. Of course, there are pros and cons to utilizing trade credit with your business, but it may be the best way forward for your business needs.
Many small business owners are dealing with a reduced cash flow this year, which means they may be turning to new suppliers and negotiating invoices and payments. The payment terms are essential in determining the amount due and the invoice amount, which can include the total amount due, the timeframe for payment, and the interest rates for late payments. Depending on the size of your businesses, and your monthly revenue, your terms will be tailored to you.
For some businesses, it is important to look at the payment options based on the amount of liquid capital available and the projected sales ahead. Liquid capital is a readily available asset, such as a checking account, that can be immediately used to pay for costs. Because not all businesses have the same liquid capital and may be operating with debt in the red instead of black, it is important to outline invoice payment terms early in the relationship with a new supplier. Some businesses may be able to pay the full amount of the invoice upfront, while other businesses may defer payments with Net-30 terms that allow 30 days until payment is due in full. (There are variations of Net-30 including 45, 60, and 90-day variations.)
Discussing terms and plans with new clients is important to avoid late fees and focus on interest-free payments that work for you both. On the flip side, incentivizing early payment discounts can help you maximize cash flow (as the supplier) or save money on the invoice (as the customer). If you opt for a Net-30 plan, you have agreed to defer payment on a regular basis. Some of this has to do with trade credit (which we explain more below), but mostly it has to do with how much working capital you have to pay bills and produce materials. Determining your cash flow can help negotiate favorable invoice payment terms.
Looking at your small business, operational cash flowincludes “all cash generated by a company’s main business activities.” This can vary depending on whether you are focused on production or retail – your cash flow could be centered on selling goods to retailers as a supplier or selling goods to customers as a vendor. Theworking capital available is also based on the amount of money brought in to the business that can be readily used to pay for costs. In either case, having cash flow and working capital will determine your invoice and payment terms.
For example, if your cash flow is good throughout the month or quarter but hits its peak working capital at the end of the month or quarter, then you want your invoice to be due then – when you have the most capital and cash available for payment. On the flip side, if you are the one receiving payment for goods, you want to ensure that payment comes before you need to pay your bills and that the receivables you send are on time (just as you want invoices to be paid on time).
Both the vendor and supplier are businesses that need cash and capital to operate. By ensuring terms with vendors or suppliers that allow you to pay invoices on time and receive goods on time, you are creating a working relationship that is beneficial to both parties.
When you invoice a supplier, a lot of the decisions about early payment periods – whether to charge interest and when late charges accumulate – have already been determined in your invoice payment terms (see above for more). Right now, the important things are that the invoice is getting to the right person – be it a vendor, supplier, or freelancer – and that it is in accordance with the payment arrangement.
Some payment methods have to do with trade credits, a comment practice where vendors supply goods or services with an agreement to bill later (which is the invoice). The trade credit allows the customer the opportunity to pay back when their cash flow or working capital are high enough to absorb the cost. At the end of the day, it is important to know how much liquid capital your business has, the projected sales, the ability to cover expenses without immediate payment, and the rates of on-time payment – all of which can help determine the terms for trade credit or payment options.
Trade credits are part of the invoice payment terms from the beginning and it can change some ways in which invoices are processed. For example, a trade credit could extend the time of billing if the client uses bank transfer instead of a credit card. The trade credit can also be used to seek longer payment terms as a way to pay the invoice in full versus installments. They can also help ensure that the payment is not delinquent and does not hurt the supplier or customer with penalties.
Examining the terms for invoice payments are hugely important – even up to the day the invoice is sent. Before the pandemic, using on the day payments for invoices may have worked well but now the incoming cash flow may mean that paying invoices on a monthly basis is more beneficial to your bottom line. It is important to determine what process works best for you and who you’re working with on the other end of the invoice.
Your business can be successful by focusing on invoice payment term options with vendors and suppliers. Being upfront about your needs to pay invoices can be helpful in securing good terms and ensuring that payment is in full and on time.
We’ve talked a lot about trade credits, invoices, and different ways to ensure that both parties are getting paid. These are important for all businesses, but you may find that certain part of this article work best for you – trade credits, Net-30 payments, deferred payments, and so on – and you should use them when negotiating invoice terms and payment options.
At the end of the day, the most important thing is that you are either paid (if you’re a supplier) or paying (if you’re a vendor) according to the terms set out in your initial contract. If you are having trouble paying, you can renegotiate terms with the other party, or look at alternate financing measures that can help your business stay afloat. (For instance, PPP programs from the CARES Act this year were geared towards small businesses ensuring they can pay costs including suppliers and employees.)
Looking ahead to the new year, it is time to see if your payment terms and contracts work well for you. Ensuring that you have enough operational cash flow to pay bills – or are switching to trade credit or a Net-30 model – is integral to your business’s survival and ensuring receivables and payments are on time.
If you need help with additional loans or credit, Biz2Credit is here to help.