What happens when good trade credit goes bad?
Trade credit enables businesses to exchange goods or services without an immediate cash transaction. Instead, the businesses make an agreement for the buyer to pay the amount owed in a fixed period of time. This service can be extremely beneficial for businesses without the immediate cash flow available to pay for a service or product upfront, especially for start-up businesses who have trouble securing finance from high street lenders.
Suppliers can benefit from a trade credit agreement in a number of ways, including new partnerships, larger contracts and greater customer loyalty. The goal for most businesses is not to profit off fees from late payments, but to generate and build new business relationships by supporting businesses who would otherwise be unable to use their services outright.
Everything considered, offering trade credit can be a very smart move and by carefully investigating the creditworthiness of your potential customers beforehand, you can establish strong relationships with trustworthy and reliable borrowers.
However, as every entrepreneur knows, things don’t always go to plan. We take a look at the potential pitfalls of offering trade credit.
Disrupt your own immediate cash flow
If your business is considering offering trade credit you will need to consider whether you can afford the delayed revenue in the meantime. For larger companies, this may not be as much of an issue but for SMEs operating on thin margins already, you’re reliant on the other company sticking to the agreement. You can work around this by being careful with the amount of trade credit you offer and the period in which you agree for it to be paid back.
Refusing to pay
No matter how careful your vetting process is, there will inevitably be someone along the line who refuses to pay the full amount of what they owe, making excuses along the way. Whilst some bad debts can be written off without causing too much damage, this isn’t the case for all and some could have a major impact on the anticipated cash flow of your business. This can be mostly avoided by only offering credit to trusted customers and acquiring references.
Not only does managing multiple trade credit agreements across different businesses take up valuable resources, but there are also other checks you will need to undertake in advance of making an agreement. You will need to review credit reports, obtain references and review the previous trading history of the business in question. You will also need to seek professional help to draw up terms and conditions and ensure you have the internal resources in place to chase up payments. Whilst this could all very much be worth your while, it’s vital to take the admin time and cost required into account, especially when taking upon multiple trade credit agreements.
If a borrower becomes insolvent before paying a loan, it can be a lengthy and difficult process to get back the money you are owed and often, it’s not always possible to get it back. At this point, the borrower is unable to pay back the loan so if you need it in the specified time periods, you could struggle.
Protecting your business
The best way to protect your business if you offer, or are considering offering, trade credit agreements as a supplier is to protect your business with Trade Credit Insurance. This protects your business if a borrower does not or cannot pay you under your agreed terms. Your policy will pay out a percentage of the overall debt back to your company, which usually ranges between 75-95% of your invoice, dependent on the cover you take out.
To find out more about Trade Credit Insurance and how Watkin Davies can help you find the right cover, call us on 02920 626 226.