Trade Credit Finance: The Advantages and Disadvantages
The Trade credit is basically a kind of short-term financing which permits the businesses to purchase the goods as well as services from the suppliers devoid of paying them upfront. On the other hand, the Trade credit is usually used in the International Trade, where the buyers as well assellers face the various kind of uncertainties as well as risks. The Trade credit may also assist the businesses to simply overcome any kind of the cash flow problems, enhance the sales, as well as grow the entire set of operations. On the other hand, trade credit even has different set of disadvantages, like cost related to the late payments, also risk for being a default, as well as about impact related to the financial ratios. In the blog below, let us now discuss different advantages as well as disadvantages related to Trade Credit Finance, and how you will manage it in an effective way.
Below mentioned are some of the benefits of trade credit finance:
1. Business growth: Trade credit can enable businesses to expand their market share, enter new markets, and diversify their product range. By offering trade credit to their customers, suppliers can increase their sales volume and revenue. With such trade credit from the suppliers, even the buyers will be able to reduce the working capital requirement and invest in different areas of their business. Also, Trade finance service can even help the businesses to simply access new set of sources related to financing, like factoring as well as invoice discounting, when they may sell the receivables to the third party for instant cash.
2. Flexibility: The Trade credit is considered to be the flexible kind of financing which may be customised to the particular needs & preferences of sellers as well as buyer. The letter of credit and terms may also differ as per the industry, product, customer, along with market conditions. Such trade credit may even be adjusted as per the changes in supply, demand or also the prices. For instance, a supplier might also offer some kind of the longer terms of payment or discounts to your loyal customer, as well as the buyer that might also negotiate a short set of payment terms as well as lower prices with the new supplier.
3. Convenience: Also, trade credit is known to be the convenient kind of financing which does not need any kind of formal agreement, legal documents as well as collateral. Trade credit is also based upon complete trust as well as reputation between seller and buyer. Trade credit may even help to save time as well as money for both sets of parties, since they don’t need to deal with the financial intermediaries and banks. The Trade credit may help to simplify the process of accounting and tax since it does not involve the fees or any other interest.
1. Cost: There is no doubt to the fact that the trade credit might be quite costly for both buyer as well as seller if they do not receive or does not pay the payments well on the time. The Late payments may result in the penalties, loss of discounts and interest charges. Also, the Late payments will even damage relationships which are between these sellers and buyers, and affect the credit ratings. Moreover, early payments will help to reduce cash flow along with profitability of buyer, since they also lose the chance to use the money for different purposes.
2. Risk: The Trade credit may also expose both buyer along with seller to different kinds of risks, like the default, theft, fraud as well as damage. When the buyer does not pay the debts, the seller might also incur the losses or they may even face issues related to cash flow. When the seller fails to simply deliver the goods or services, the buyer might even face any kind of disruptions and delays in the operations. Moreover, the trade credit may even increase any kind of exposure to the foreign exchange risk, to the political risk, even the legal risk, particularly in Global trade.
3. Impact: The Trade credit may also have the substantialimpact on financial ratios as well as various performance indicators for both sellers and buyer. These may affect solvency, liquidity, profitability, along with efficiency ratios of related parties. For instance, trade credit will enhance current ratio which decreases quick ratio for buyer, this indicates the lower position of liquidity. Moreover, Trade credit may even increase accounts payable and the turnover ratio which helps to decrease the accounts receivable and the turnover ratio of seller, that indicates the position of lower efficiency.
How to Manage Trade Credit Finance?
Trade credit finance can be a useful tool for businesses to improve their cash flow and sales, but it also requires careful management and control. Some of the best practices for managing trade credit finance are:
1. Establish clear terms and conditions: Both the buyer and the seller should agree on the terms and conditions of trade credit before entering into a transaction. The terms should include the amount, duration, due date, discounts, penalties, interest rates, and dispute resolution mechanisms of trade credit. The terms will even get communicated clearly as well as reliably to avoid any kind of misunderstandings as well as conflicts.
2. Monitor collections and payments: Both sellers and buyer must also monitor the payments and collections accurately and accurately. These must also use accounting software as well as systems to track the invoices, balances, receipts, aging reports along with the statements of cash flow. They must even follow up with the customers and with the suppliers promptly when there are delays as well as discrepancies in the collections or payments.
3. The Trade credit finance is known to be the crucial and common form of financing for the businesses, those who are particularly dealing in international trade. The Trade credit will offer various advantages, like business growth, convenience and flexibility, but it may even pose some disadvantages, like cost, impact and risk. Trade credit finance needs some kind of careful management along with proper control, and both sellers and buyers follow some set of best practices, like forming clear terms & conditions and also monitoring the payments as well as collections with good relationships.