Trade Credit

Trade credit is credit extended by suppliers. Ordinarily, it is the first source of extra capital that the small business owner turns to when the need arises.

Informal Extensions.   Frequently, this is done with no formal planning by the business. Suppliers' invoices are simply allowed to ride for another 30 to 60 days. Unfortunately, this can lead to a number of problems. Suppliers may promptly terminate credit and refuse to deliver until the account is settled, thus denying the business access to sorely needed supplies, materials, or inventory. Suppliers might also put the business on a C.O.D. basis, requiring that all shipments be fully paid in cash immediately upon receipt. At a time when a business is obviously strapped for cash, this requirement could have the same effect as cutting off deliveries altogether.

Planning Advantages.   A planned program of trade credit extensions can often help the business secure the extra capital it needs without recourse to lenders or equity investors. This is particularly true whenever the capital need is relatively small or short in duration.

A planned approach should involve the following:

• Take full advantage of available payment terms. If no cash discount is offered and payment is due on the 30th day, do not make any payments before the 30th day.
• Whenever possible, negotiate extended payment terms with suppliers. For example, if a supplier's normal payment terms are net 30 days from the receipt of goods, these could be extended to net 30 days from the end of the month. This effectively buys an average of 15 extra days.
• If the business feels that it needs a substantial increase in time, say 60 to 90 days, it should advise suppliers of this need. They will often be willing to accept it, provided that the business is faithful in its adherence to payment at the later date.
• Consider the effect of cash discounts and delinquency penalties for late payment. Frequently, the added cost of trade credit may be far more expensive than the cost of alternate financing such as a short-term bank loan.
• Consider the possibility of signing a note for each shipment, promising payment at a specific later date. Such a note, which may or may not be interest-bearing, would give the supplier evidence of your intent to pay and increase the supplier's confidence in your business.

Ready Availability.   Trade credit is often available to businesses on a relatively informal basis without the requirements for application, negotiation, auditing, and legal assistance often necessary with other capital sources.

Usage.   Trade credit must be used judiciously. Its easy availability is particularly welcome in brief periods of limited needs; used imprudently, however, it can lead to curtailment of relations with key suppliers and jeopardize your ability to locate other competitive suppliers who are willing to extend credit to your business. Remember that on the other side of the transaction, there is another business that is trying to manage its sources of capital, too!

Debt - Types & Availability

Debt Capital.  Debt is an amount of money borrowed from a creditor. The amount borrowed is usually evidenced by a note, signed by the borrower, agreeing to repay the principal amount borrowed plus interest on some predetermined basis.

Borrowing Term.   The terms under which money is borrowed may vary widely. Short-term notes can be issued for periods as brief as 10 days to fill an immediate need; long-term notes can be issued for a period of several years.

Discounted Notes.   In some cases, particularly in short-term borrowing, the total amount of interest due over the term of the note is deducted from the principal before the proceeds are issued to the borrower. Such a note is called a discounted note.

Short-term Borrowing.   Short-term borrowing usually requires repayment within 60 to 90 days. Notes are often renewed, in whole or in part, on the due date, provided that the borrower has lived up to the obligations of the original agreement and the business continues to be a favorable lending risk.

Credit Lines.   When a business has established itself as being worthy of short-term credit and the amount needed fluctuates from time to time, banks will often establish a line of credit with the business. The line of credit is the maximum amount that the business can borrow at any one time. The exact amount borrowed can vary according to the needs of the business, but cannot exceed its established credit line.

These arrangements give the business access to its requirements up to the credit limit or line. However, it pays interest only on the actual amount borrowed, not the entire line of credit available to it.

Long -term Debt.   Long-term debt is borrowing for a period greater than one year. This general classification includes intermediate debt, which is borrowing for periods of one to 10 years.

Repayment Schedules.   When the terms of a debt are negotiated, a payment schedule is established for both interest obligations and principal repayment. The dates on which principal and interest payments are due should be scheduled carefully. For example, a manufacturer with heavy sales just before Christmas and receivables collections through January might best be able to schedule repayments in February. If a payment were due in October or November, when inventories were high and receivables were climbing, the payment could be crippling.

Mortgage Loan Repayment Schedules.   Principal and interest payments on mortgages usually involve uniform monthly payments that include both principal and interest. Each successive monthly payment reduces the amount of principal outstanding; therefore the amount of interest owed decreases and the portion of the monthly payment applicable to principal increases. In the early years of a mortgage, the portion of the monthly payment applied against the principal is relatively small, but grows with each payment.

Term Loan Payment Schedules.   For term loans, payment of principal and interest is ordinarily scheduled on an annual, semiannual, or quarterly basis.

For example, a 5-year, $50,000 term note bearing 10% interest might have the following payment schedule specified in the note agreement:

Availability.   Commercial banks are the ordinary source of short-term loans for the small business. For small businesses, borrowed capital for periods greater than 10 years is usually available only on real estate mortgages. Other long-term borrowing usually falls into the intermediate classification and is available for periods up to 10 years. Such loans are called term loans.

Selecting Type and Term.   The type and term of the loan should be based on the purpose for which the funds will be used. Your banker or accountant can help you determine what type of loan is best to meet your needs. See if you can pass the test and match the loan request with the appropriate borrowing arrangement.

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