What is trade credit and how does it work for a business?

Full answer

Trade credit is an arrangement where a supplier delivers goods or services and lets you pay after an agreed period -- commonly 30, 60 or 90 days -- rather than upfront. It is the most widely used form of short-term business finance in the UK and affects almost every company that buys stock or services from other businesses. The mechanism is simple. The supplier issues an invoice with payment terms; you receive and can use or resell the goods before paying. This frees up working capital: a retailer can sell stock and collect cash from customers before the supplier's invoice falls due. It is usually interest-free, which makes it attractive compared with an overdraft or loan. The cost is not always zero, though. Suppliers often offer an early-settlement discount (for example, 2% off for paying within 10 days instead of 30). Declining that discount to take the full credit period is an implicit cost, and on an annualised basis it can be expensive. Late payment carries harder costs: under UK late-payment legislation you may owe statutory interest plus compensation, and persistent lateness damages your supplier relationships and your business credit score, which affects future terms. Worked example: a wholesaler offers 60-day terms on a GBP 20,000 order. You sell the stock within 45 days, collect the cash, and pay the supplier on day 60 -- using their money interest-free for nearly two months and improving your cash position without borrowing. Trade credit also has VAT and accounting timing implications: VAT is generally accounted for by the invoice date, not the payment date (unless you use cash accounting), so you may owe output VAT before the customer has paid you. Manage trade credit alongside your wider cash-flow planning, and weigh early-payment discounts against the cash-flow benefit of holding the money.

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