When people think about business finance, they often imagine bank loans, overdrafts or investors. What many do not realise is that one of the biggest sources of short-term funding is something far simpler. It is trade credit.
According to the International Monetary Fund, trade finance, which includes trade credit, supports around 80 per cent of global trade. This means that four out of five transactions that help goods move around the world rely on an agreement where payment happens later rather than at the point of purchase.
For many businesses, offering credit is not just a kind gesture. It is a practical choice that helps them stay competitive, secure customers and manage cash flow.
In this article, we look at what trade credit is, why suppliers offer it, how it works in real business situations and how strong credit control and debt collection practices help reduce risks. We also include examples from well-known companies and explain how you can manage trade credit safely and sensibly.
What Is Trade Credit?
Trade credit is a simple idea. A customer buys goods or services now and pays for them later. Instead of handing over money at the time of purchase, the customer receives an invoice and settles it at an agreed date.
This could be 30, 60 or even 90 days from delivery. It is short-term, interest-free finance built directly into everyday trading. It is very common in industries where regular purchasing is essential, such as manufacturing, wholesale and construction.
The appeal of trade credit is that it frees up cash. A business can order stock, sell it on, generate income and then pay for the goods from that income. This cycle is one reason why so many firms use it.
In fact, it plays such a large part in business finance that some major companies rely on it far more than traditional borrowing. For instance, Tesco plc recorded £4.9 billion in trade payables in its 2017 accounts. At the same time, its bank loans and borrowings were only £2.6 billion. This highlights the scale of inter-firm financing and how important it is to supply chains.
Trade credit appears in various forms. Some suppliers offer an open account which simply means pay later. Others provide early payment discounts. Some require staged payments. There are many ways to structure the arrangement to suit both the buyer and the seller.
How Trade Credit Works for Businesses
The operation of trade credit is fairly straightforward.
- A customer places an order.
- The supplier delivers the goods or completes the service.
- An invoice is issued with a payment date.
- The customer pays at the end of the agreed period.
- The time between delivery and payment gives the buyer space to generate cash.
When used well, it supports growth and helps a business take on more work.
A famous example from business history shows how powerful trade credit can be. When Steve Jobs and Steve Wozniak started Apple, they managed to secure an order for 50 Apple I computers. They did not have the money to buy the components.
Jobs contacted Cramer Electronics and negotiated 30-day terms. This meant they could buy the parts, build the computers, deliver them, collect payment and then settle the invoice. Not only did this allow them to complete the order but they were also left with money to fund the next batch.
They did not need a loan or investor. Trade credit gave them the breathing room they needed. It is a simple arrangement, yet it played a part in launching a company that would later become one of the largest in the world.
Why Businesses Give Trade Credit
If trade credit helps buyers, why would suppliers take the risk of offering it? On the surface, delaying payment means increased exposure to late payments, defaults and the possibility of having to deal with debt collection. However, there are several reasons why businesses still choose to extend credit.
The first and strongest reason is competition. In markets where several suppliers offer similar products at similar prices, the terms of payment can be the deciding factor for buyers. A customer may choose the supplier who offers 30 or 60 days to pay rather than the one who insists on upfront payment.
Research supports this and shows that firms operating in more competitive markets tend to offer trade credit more frequently and on more generous terms. For some customers who are short of working capital, the payment terms matter more than price. As a result, offering credit provides a commercial advantage. It helps suppliers win contracts and secure regular orders.
A second reason is that trade credit can encourage customers to order more frequently. When payment is delayed, buyers feel more confident placing larger or more regular orders. This supports growth and helps build long-term relationships. Once a customer trusts a supplier, they are more likely to stay with them.
Another consideration relates to administration. Without trade credit, a supplier dealing with customers who place many orders each week would need to take payment for every individual transaction. This becomes time-consuming for both sides.
With trade credit, the supplier can group all orders into a single invoice or monthly statement. This keeps things simpler. Although customers could pay money into their account in advance, this is less common and does not explain the popularity of longer terms such as 60 days.
Trade credit also supports the wider supply chain. Many businesses would struggle to operate if they had to pay for all goods upfront. Delaying payment allows production and distribution to continue smoothly. It is a long-standing part of how companies fund themselves through normal activity.
The Pros and Cons for Buyers and Sellers
For buyers, the advantages of trade credit are clear.
- They gain extra time to pay, which supports their cash flow.
- They can take on more customers and purchase the materials they need without the pressure of paying immediately.
- They do not have to rely on expensive bank borrowing.
However, there are drawbacks. If the buyer fails to sell the goods quickly enough or has a period of slow income, they may struggle to meet the payment deadline. Late payments can damage business credit scores, lead to penalty charges and strain relationships with suppliers.
For sellers, there are significant advantages as well. Offering trade credit helps attract new customers and secure orders. It can increase sales and make the supplier more appealing than competitors who do not offer terms. It also encourages loyalty.
However, suppliers carry financial risk when offering credit. Cash can become tied up in unpaid invoices. Late payments can cause cash flow problems. There is always the possibility of default, which may lead to a need for debt collection. This is why strong credit control processes are important. Without them, the supplier may expose the business to unnecessary risk.
How to Manage Trade Credit Sensibly
Although offering trade credit comes with risks, they can be reduced with good habits and clear systems. Before offering credit terms, a supplier should check the customer’s creditworthiness. Many online tools and credit agencies can help with this. Understanding the financial strength of the customer makes it easier to set sensible limits.
Invoices should always be accurate. Errors create delays, disputes and confusion. Clear statements and friendly payment reminders make it more likely that customers pay on time. It also helps to request confirmation of planned payment dates. Automation can support this process and reduce the time spent chasing customers.
Credit limits should be set carefully. They should reflect both the financial position of the customer and the supplier’s ability to cope if a payment is delayed. If a customer consistently pays late, it might be necessary to review their terms. Managing credit is an ongoing process, not a one-time decision.
If payments become overdue, it is important to act promptly. Waiting too long can make recovery harder. A well-structured approach to debt recovery protects cash flow and often resolves issues before they escalate. When needed, a professional debt collection service can help recover funds while maintaining a professional relationship with the customer.
Why Trade Credit Matters for Modern Businesses
Trade credit continues to be one of the most widely used tools in business finance. It helps suppliers win customers and grow their sales and it helps buyers manage cash flow and fund their daily operations. We looked at how it works, why companies choose to offer it and the steps businesses can take to reduce risk. Whether the business is a major retailer, a small supplier or a new start-up, trade credit can make everyday trading more flexible and support long-term growth when managed properly. If you want guidance with credit management, debt recovery or smoother payments, contact My Credit Controllers today.
