80-90% of all global trade relies on trade finance in one form or another.
Published 2nd February, 2023
Last updated 23rd March, 2023
Trade credit is a business-to-business financial arrangement where a supplier allows a customer to purchase goods or services and pay for them at a later date. Trade credit is also known as accounts receivable, business credit, purchasing on invoice or net terms.
B2B trade credit is a type of financing widely used around the world. In fact, 80-90% of all global trade relies on trade finance in one form or another. For buyer and seller alike, trade credit can be a valuable form of financing to help increase sales and build relationships.
But how does B2B trade credit actually work? What are the advantages and disadvantages of trade credit? And why should you be offering it to your customers? Continue reading to learn the answers to these questions and more.
How does trade credit work?
When you offer a buyer B2B trade credit, you’re allowing them to purchase goods and pay you at a later date. The process for actually setting this up can vary greatly, but generally these are the basic steps of how B2B trade credit works:
- Credit approval - If you’re extending a line of credit to a customer, you want to know they can pay their invoice when the time comes. This means assessing the customer or business’s credit history and performing other due diligence.
- Setting credit limit - Once a customer has been approved, you need to establish how much credit they’re willing to give. This’ll be based on what has been discovered during the customer assessment.
- Setting payment terms - The terms of the trade credit, like the credit limit and length of time before payment is due, are typically negotiated between you and the customer. Most commonly though, these terms are 30, 60, or 90-days, after which point the seller collects their payment.
More recently, this process has been outsourced to advanced financial technology, making B2B trade credit a whole lot easier to manage as a business. Two’s B2B payment suite, for example, covers all three of these steps!
What is trade credit insurance?
B2B trade credit insurance (or B2B credit insurance) is a type of insurance that protects your business from the financial risks that come with extending credit to customers. This insurance can protect you against losses from late or non-payments, mitigating risk. It can also help to manage and monitor credit risk more effectively.
One of the biggest players in the game for trade credit insurance is Allianz Trade. As the global leader in trade credit insurance, they’re recognised specialists in the areas of surety, collections, structured trade credit and political risk.
Two recently announced the exciting news that we’ve partnered with Allianz Trade and Santander. This allows us to provide our B2B Buy Now, Pay Later solutions to large multinational corporations!
Types of trade credit
There are three main types of payment methods in trade: Trade Acceptance, Open Account, and Promissory Note.
- Trade Acceptance involves formal documentation between the buyer and the seller, with an official draft document drawn up by the seller before shipping the goods. If the buyer accepts and signs the draft, then it clarifies its acceptance, and the draft becomes trade acceptance.
- Open Account, on the other hand, does not involve any formal agreement between the parties.
- Lastly, the Promissory Note is a formal document that needs to be signed by the buyer to extend an open account that is already in existence before the due date.
Trade credit advantages and disadvantages
So what are some of the pros and cons of trade credit? One of the advantages of trade credit is that it allows B2B buyers to secure a product or service, manufacture what they need and then make a profit - all before making a payment. This means their cash flow is much easier to manage.
Of course, the advantages aren’t just limited to buyers. Trade credit can be leveraged to boost B2B sales by giving customers an attractive financing alternative.
However, it’s important to understand the full list of advantages and disadvantages of trade credit. Let’s explore in more detail.
Trade credit advantages
Sellers
Increased sales
By offering B2B trade credit, you’re giving customers the opportunity to purchase more easily from you. Offering trade credit is a great way of generating more sales. In fact, 55% of all B2B sales are on trade credit in Western Europe.
Win new customers
Many of your potential customers are simply not in the position to purchase from you without trade credit. One of the other benefits of trade credit is that you’re able to capitalise on a whole market of buyers previously unavailable to you. In Eastern Europe for example, 40% of businesses offer trade credit to win new business.
Increased customer loyalty
With any credit agreement, there is a certain level of trust involved. As a merchant, you are responsible for either credit checking the customer yourself or working with a third party to do it for you.
But that doesn’t mean there’s no risk, and the customer knows that. Extending this trust towards your customers helps to build customer loyalty and increase repeat business over time.
Buyers
Improved cash flow
Being able to obtain inventory and generate income from the product or service they create before paying for goods is a huge win for sellers. Cash flow is much more easily managed as the term length gives them the opportunity to generate sales and use the profits to settle their debts.
Increased purchasing power
Without B2B trade credit, buyers have little option but to pay then and there for what they need. Purchasing on trade credit however allows B2B buyers to increase their purchasing power and acquire the resources they need to grow their business.
Affordable financing
Compared to other financing options for buyers like bank loans or credit cards, B2B trade credit is far more affordable. If fact, it's free for buyers! Late payment fees will of course apply, depending on the agreement they have with the seller. But using B2B trade credit is a free process.
Trade credit disadvantages
Sellers
Cash flow issues
With B2B trade credit, you’re effectively postponing when you get paid, leading to cash flow issues. The reality is you’ll have to run your business without that income until you receive payment. This means it’s super important to record accounts receivables as an asset on your balance sheet, helping you keep track of what you’re owed.
To reconcile these issues, many B2B companies turn to a few different solutions. For example, you could:
- Apply for a credit line through your bank.
- Work with an accounts receivable financing or factoring company
- Use a B2B payment solution like Two. We’ll jump into how Two can fix these problems and more in just a bit.
Credit and fraud risk
As a merchant, you take on the credit and fraud risk for trade credit purchases. Any B2B sale on trade credit runs the risk of non-payments which can have dire consequences for your cash flow and business as a whole.
Fortunately, there are trade credit insurers, as mentioned earlier. This will help cover any non-payments from your buyers and protect your business.
You’ll also need to establish the buyer’s creditworthiness. Less formal operations often make that assessment internally based on existing relationships, but it can be risky. There are credit risk management companies out there too to help you manage this more comprehensively.
As a side note, Two takes care of this for you!
Operational complexity
Managing invoices in-house requires time and effort and unless you have a dedicated team to deal with this, you’ll find a lot of your time can be spent organising paperwork. This means manually filling out invoices, sending them to your buyers, and reconciling payments. All of which can be an operational struggle.
Buyers
Late payment fees
If a buyer doesn’t pay their invoice in the allocated term, it’s common for sellers to charge them a late payment fee. Sellers struggling with cash flow can find themselves unable to pay their invoices on time, resulting in further charges they need to pay.
Damaged reputation
If a buyer doesn’t pay their invoice in the allocated term, it’s common for sellers to charge them a late payment fee. Sellers struggling with cash flow can find themselves unable to pay their invoices on time, resulting in further charges they need to pay.
What is a trade account in business?
Business trade accounts allow a company to purchase goods or services on credit from another company. This means they can receive the goods or services now and pay for them at a later date, usually with interest.
Trade accounts are commonly used in industries such as manufacturing, retail, and wholesale, where large volumes of goods or services are exchanged between businesses. They can help businesses to manage cash flow, build relationships with suppliers and customers, and simplify the buying and selling process.
How to get a trade account
The process of setting up a trade account for both your customer and you can be a tedious experience. You want to make it as easy as possible for your B2B customers to purchase from you using trade credit. We’ve covered the advantages and disadvantages of trade credit for both you and your customers, but it’s worth reiterating again;
The sheer time it takes to get a customer up and running with trade credit can drastically impact your business. Manual onboarding and credit checks slow the entire purchasing journey down when you could be selling.
But with Two, it happens in seconds!
Be sure to check out our B2B Trade Account solution to learn more.
Why you need to offer trade credit
While COVID-19 put the world on pause for 2 years, some positive advances in the B2B space emerged. The BNPL B2C model is making its way over to B2B and now, more and more business customers are expecting an experience akin to their B2C purchases.
This can be partly explained by how familiar B2B buyers are with financial technology. Given 73% of all professional B2B purchasing decisions are made by millennials, the increasing assumption is that B2B companies will offer the same seamless purchasing experience as B2C.
And that includes offering net terms. For example, a study by McKinsey found that 96% of B2B buyers might make a purchase in a fully end-to-end, digital self-serve model. Offering trade credit becomes not just preferable but expected by B2B buyers and one of the leading reasons you should offer B2B trade credit solutions.
Two - The Complete B2B Payment Suite
Selling B2B with Buy Now, Pay Later can be incredibly complex. But it doesn’t have to be. With Two’s B2B payment suite, you can increase conversion rates and average order value while eliminating admin and offsetting credit risk.
Whether you want to supercharge your B2B e-commerce checkout for guest purchases, optimise your trade account with frictionless onboarding, or offer B2B BNPL on all sales channels - Two is here to help.
Two’s payment technology enables businesses across all industries to offer purchasing on invoice, providing a frictionless checkout experience with instantly approved credit. Our revolutionary B2B solutions simplify the payment journey so businesses can access working capital and increase B2B sales while reducing time consuming operational work.
