The truth is, almost all business owners would prefer cash sales- but this isn’t always feasible if you want to remain competitive in the marketplace. There will likely be instances when you will need to offer credit terms to get customers to purchase your products and services. Unfortunately, this opens up a whole new aspect to running a business. Now, you have to manage the trade credit offered to customers. In this blog, we’re going to examine the advantages versus the disadvantages of offering trade credit to your customers.
Advantages of Trade Credit
There are several advantages of offering trade credit lines to your customers. We’ll examine those below.
If a customer doesn’t have to pay cash upfront, they are more likely to buy more of your products or services. Most often, sellers offer 30-day payment terms- it is very rarely extended beyond this.
When you extend credit to your customers, you are letting them know that you believe they are trustworthy and will pay their bills on time. The customer will then reward that confidence by making purchases.
When you offer credit to your customers, you have an advantage over your competitors who are not able to do the same. After all, most consumers would prefer to purchase from a seller that allows them to purchase with credit than to have to pay cash for everything.
Incentives for Customers to Pay
Even if the payment terms are 30 days, many sellers encourage customers to pay early by offering them a discount if they pay within a certain period. This is a major incentive for customers to get their accounts paid off early. On the other hand, if they don’t pay early, they run the risk of paying a high-interest rate to delay the payment for the extra 20 days.
Disadvantages of Trade Credit
Of course, when you’re considering something like offering trade credit to your customers, you need to take a look at the disadvantages as well. Below, we’ll take a closer look at these.
Negatively Affects Cash Flow
The primary disadvantage of offering trade credit is that you don’t get cash upfront for the sale. As a seller, you have bills that need to be paid as well, and offering credit creates a gap in your cash flow.
Must Run Credit Checks on Customers
Just like a lender, if you plan to offer credit to your customers, you must analyze their credit score. This takes time and money because you must pay to access credit reports, and it takes time to call references. You may need to hire someone who specializes in credit analysis to help make credit decisions.
Must Monitor Accounts Receivable
When you extend credit, you increase your accounts receivable, and someone will have to monitor those accounts to ensure customers are making timely payments. If you run on a cash-only basis, you don’t have to worry about this.
Must Finance Accounts Receivable
When you extend credit, you must finance your receivables. You may need to lean on your suppliers for trade credit, use your retained earnings, or borrow from the bank. These will all have a natural effect on your capital
Risk of Bad Debt
Of course, there is always the risk that customers won’t pay their debts. This will require an employee to make collection calls and eventually, you may need to write off the debt and incur a loss.
All of that being said, in most industries, it’s common to extend trade credit. After all, if you want to remain competitive, it’s almost a requirement. However, as you can see, there are a few risks involved as well. Contact Sterling Capital Consulting today to find out if your business is in a position to offer trade credit and how you can get started.