Loading the player...

What is a 'Trade Credit'

A trade credit is an agreement where a customer can purchase goods on account (without paying cash), paying the supplier at a later date. Usually when the goods are delivered, a trade credit is given for a specific number of days – 30, 60 or 90. Jewelry businesses sometimes extend credit to 180 days or longer. Trade credit is essentially a credit a company gives to another for the purchase of goods and services.

BREAKING DOWN 'Trade Credit'

The amount of days for which a credit is given is determined by the company allowing the credit, and is agreed upon by both the company allowing the credit and the company receiving it. With the extension of the payment date, the company receiving the credit could sell the goods and use the net proceeds to pay back the debt. This type of credit is sometimes given to encourage sales. At times, a supplier may give a discount, if the customer pays within a certain period of time. For example, a 2% discount if payment is received within 10 days of issuing a 30-day credit.

Trade credit applies to business-to-business trade, and has been an essential way for businesses to finance short-term growth. Vendors or suppliers do not typically extend trade credit to businesses that have yet to establish good credit, or have not proven that they are able to make payments on time. However, trade credit is a useful option for businesses to receive supplies crucial to growth without paying immediately. This way they can sell their product before payment is due, or use the freed up cash flow for other business purposes.

Another way of thinking about trade credit is as a form of short-term debt, and yet it does not require any outright interest, is often in the form of an informal contract, and is not issued by any bank or financial institution. Still, if a supplier or company is not paid within the trade credit agreed terms, penalties in the form of fees and interest can be incurred. It is worthwhile to note that generally the supplier has a vested interest in the survival of the company to which it has extended the trade credit. This ongoing business relationship is different from that of a typical bank and loan borrower in that the supplier can choose to be more flexible with repayment terms; and in fact, often chooses to do so.

‘Trade Credit’ Trends

Trade credit is most rewarding for businesses that do not have a lot of financing options. After the 2008 financial crisis, traditional financing options for small businesses, such as debt and equity financing, became increasingly limited. Evidence of this is seen in the relatively recent rise of alternative means of financing, such as crowdfunding and peer-to-peer lending.

From an international standpoint, studies have found that in countries outside of the United States, trade credit accounts for approximately 20% of all investment financed externally. Bank credit was the only form of financing more significant than trade credit, showing that in most of the surveyed countries, trade credit was the second most important financing option.

Similarly, research conducted in the U.S., such as that of the Survey of Small Business Finances by the Federal Reserve Bank, demonstrate the importance of trade credit. Trade credit is used by approximately 60% of small businesses in the U.S., rendering it the second most popular financing option after that of banks and other financial institutions.

Related Terms & Concepts

Trade credit has a significant impact on the financing of businesses and therefore is linked to other financing terms and concepts. Other important terms that affect business financing and financial futures are credit rating, trade line and buyer’s credit. A credit rating is an overall assessment of the credit worthiness of a borrower, whether a business or individual, based on financial history that includes debt repayment timeliness and other factors. Without a good credit rating trade credit may not be offered to a business.

A trade line, or tradeline, is the credit account record provided to a credit reporting agency, such as Standard & Poor’s, Moody’s or Fitch. Buyer’s credit is related to international trade and is essentially a loan given to importers specifically to finance the purchase of capital goods and services. Buyer’s credit involves different agencies across border lines and thus typically has a minimum loan amount of several million dollars. 

RELATED TERMS
  1. Credit Rating

    An assessment of the creditworthiness of a borrower in general ...
  2. Credit Limit

    The amount of credit that a financial institution extends to ...
  3. Bank Credit

    The amount of credit available to a company or individual from ...
  4. Good Credit

    A qualification of an individual's credit history that indicates ...
  5. Credit Report

    A detailed report of an individual's credit history prepared ...
  6. Available Credit

    The unused portion of an open line of credit, such as a credit ...
Related Articles
  1. Personal Finance

    The Importance Of Your Credit Rating

    A great starting point for learning what a credit score is, how it is calculated and why it is so important.
  2. Personal Finance

    The Basics Of Lines Of Credit

    Lines of credit are potentially useful hybrids of credit cards and normal loans. Learn how a line of credit can help (and hurt) your finances, and how to find the best one to suit your needs. ...
  3. Personal Finance

    Take the Right Steps to Build Excellent Credit

    There are several things you can do to protect and improve your credit score.
  4. Investing

    Revolving Credit vs. Line of Credit

    Revolving credit and a line of credit are arrangements made between a lending institution and a business or individual.
  5. Managing Wealth

    Business Vs. Consumer Credit Reports: What's the Difference?

    Find out the difference between a business credit report and a personal credit report, and why it should matter for business owners.
  6. Personal Finance

    Is Your Credit Score at 850? It Can Be!

    Use these tips to increase your credit score and your ability to get low interest rates on loans.
  7. Personal Finance

    How To Establish A Credit History

    Can't get a credit card without a credit history, and can't get a history without a card? Break the Catch-22.
  8. Personal Finance

    How Your Credit Score Compares to the Average American's

    While only a small percentage of Americans have terrible credit scores, a whopping 30% have poor or bad credit, according to the Consumer Financial Protection Bureau.
  9. Personal Finance

    5 Tax Credits You Shouldn't Miss

    If you're not taking advantage of these deductions, you could be missing out on tax savings.
  10. Investing

    5 Ways Bad Credit Screws Up Your Life

    When your credit score slumps, many other things in your life can also start to slide downward. How to recognize the situation and start dealing with it.
RELATED FAQS
  1. What is the difference between bad credit and no credit?

    The answer to this question will depend on what information (if any) is found on your credit report, such as any bankruptcy ... Read Answer >>
  2. Is it possible to have a credit limit that's too high?

    Avoid these pitfalls when working with high credit limits, and learn how to increase your credit score by increasing your ... Read Answer >>
  3. What are some good alternatives to taking out a line of credit?

    Read more about how opening a line of credit might not be the best answer for you and determine available alternatives if ... Read Answer >>
  4. What is the difference between a loan and a line of credit?

    Learn to differentiate between lines of credit and standard loans, and determine when you are likely to use each method of ... Read Answer >>
  5. What are the benefits of credit ratings?

    Credit ratings are an important tool for borrowers to gain access to loans and debt. Good credit ratings allow borrowers ... Read Answer >>
  6. What's the difference between a credit rating agency and a credit bureau?

    Learn how to differentiate between credit rating agencies and credit bureaus, two industries that distribute valuable risk ... Read Answer >>
Hot Definitions
  1. Restricted Stock Unit

    Compensation offered by an employer to an employee in the form of company stock. The employee does not receive the stock ...
  2. Operating Ratio

    A ratio that shows the efficiency of a company's management by comparing operating expense to net sales. Calculated as:
  3. Expense Ratio

    A measure of what it costs an investment company to operate a mutual fund. An expense ratio is determined through an annual ...
  4. Pro Forma

    A Latin term meaning "for the sake of form". In the investing world, it describes a method of calculating financial results ...
  5. Trumpcare

    The American Health Care Act, also known as Trumpcare and Ryancare, is the Republican proposal to replace Obamacare.
  6. Free Carrier - FCA

    A trade term requiring the seller to deliver goods to a named airport, terminal, or other place where the carrier operates. ...
Trading Center