There’s a lot on the minds of today’s SMEs. FSB’s recent Voice of Small Business Index for Q2 2017 found that the number of SMEs expecting to downsize, close or sell on what’s left of their business in the next 12 months has increased for a second consecutive quarter, now standing at 12 per cent, whilst cost pressures have hit their highest since Q2 of 2013.
Whilst downsizing is rarely down to any one reason, paying suppliers in advance can be a significant factor that stifles the growth of SMEs. Businesses have a variety of immediate investment decisions and ongoing cash expenses to take care of on a day to day basis, which can make it hard for an SME to make upfront payments as well as commit to spontaneous or unplanned new projects.
What is trade credit?
One option that’s available for struggling SMEs that can’t get loans from traditional banks, is trade credit. Trade credit is an agreement that’s made between a supplier and customer in which the supplier agrees to supply goods upfront, with the payment coming at a later date. It essentially lets a business ‘buy now and pay later’. For example, if an SME received a big new order but little cash in hand, trade credit would allow them to take delivery of goods, without paying in advance.
Trade credit also works in a mutually beneficial way. For the business that’s on the receiving end, it can enable financial growth and prevent delays in activity by postponing payments. In the short-term, cash can be used for other immediate capital needs whilst a business waits for the return payment.
For the suppliers, it’s a means to differentiate themselves from competitors and attract more business. SMEs are more likely to partner with a supplier that offers trade credit as opposed to one that demands money upfront.
Whilst trade credit is common practice within business and when used successfully can be a very useful tool to enable growth, there are a number of things that SMEs need to take into consideration first.
As it stands, trade credit is made on a contractual basis and no contracts should be entered into blind or without a full understanding of both the benefits and potential pitfalls.
Intelligent planning: know who you’re dealing with
Offering trade credit is similar to offering a loan. So, considering that banks always run a credit check on an individual, it’s important to run one on a business too. It’s unlikely that a supplier will offer trade credit to a start-up or someone they’re new to doing business with without doing their due diligence; they’ll want to cover their own back and make sure you have an established credit-score.
Therefore, an SME will need to build a supplier’s trust first by building a healthy company credit report ready for when a supplier will come looking for one, after all they’re trusting you to pay them for the stock they’re giving you.
But it’s also important to find out more about the supplier you’re starting business with. SMEs should also check suppliers’ company credit reports to avoid entering into a contract with potential sinking ships. Creditsafe’s company credit reports can provide key financials, so you can check yourself to see if a company is struggling or thriving, this way you can be assured your stock will keep coming and you won’t be left without if your supplier goes bust.
Pitfalls and penalties
It can be easy to be blinded by the benefits, however, there are a few drawbacks SMEs should be aware of before making a decision to acquire goods on it. Late payments are a common trend in the business world and according to Creditsafe’s End of Year Review in 2016, more invoices were paid late than on time; therefore, suppliers take extra precautions when offering trade credit.
With trade credit, if an SME fails to pay a supplier within terms agreed in the contract, there will be a penalty. Penalties are put in place so suppliers are paid interest on each day the payment is late. Typically, the rate sits between one and two per cent per month, therefore if a business misses the agreed payment deadline each month for a whole year, it could be costly.
Trade credit is traditionally high even if a company’s not paying late, so if a business is one that consistently struggles to pay on time, trade credit might not be for them.
That being said, suppliers often offer appealing discounts for those savvy SMEs that pay earlier than necessary, making it important for businesses to understand both the discounts and penalties in the contract beforehand.
It’s clear that this can be a great way to relieve SMEs from the everyday cash demands that so often prevent growth. However, as with everything in the world of business, it’s not without its potential risks. An SME should conduct a full risk assessment before diving head-first into a trade credit contract, that way it can be sure to reap the benefits.
Rachel Mainwaring is operations director at Creditsafe