What is Trade Credit?
The term “Net 30” is a frequently used invoicing payment term, which means that the buyer has 30 days to make payment from the invoice date. Often, terms are longer, such as Net 45 or Net 60. These payment terms are what is called “trade credit”. Trade credit is an integral component of business transactions worldwide. At its core, trade credit is both a blessing and a curse to businesses that engage in the exchange of goods or services.
The buyer is fortunate to delay their payment for the goods or services for 30 days. From the supplier’s perspective, having to wait 30 days for payment creates a necessary burden. Essentially, it’s a short-term interest-free loan, extended by the supplier to the buyer. Trade credit often creates cash flow difficulties for businesses that sell or provide services to other businesses (B2B).
History of Trade Credit
The origins of trade credit trace back to the very roots of commerce itself. The Mesopotamians, for instance, developed an intricate system of credit and trade, with merchants often providing goods on loan that would be paid back in future harvests or profits. The system gave the buyer time to generate revenue from the goods or services received, at which point the buyer paid his supplier.
Solving Trade Credit with Factoring Finance
Factoring finance, commonly referred to as invoice factoring, is a powerful financial tool that allows businesses to tap into their accounts receivable and generate cash immediately. Instead of waiting for their customers to pay, businesses sell their unpaid invoices to a third-party company, known as the factoring company, at a discount. A factoring company, often referred to as a ‘factor’, is a financial institution that purchases businesses’ unpaid invoices at a discounted rate.
The factoring company provides cash up front, usually a significant percentage of the total invoices’ value (known as the advance rate), thus injecting instant working capital into the business. This transaction provides the business with immediate liquidity, bypassing the delay that comes with waiting for customers to pay their invoices.
In addition to purchasing invoices and advancing cash, the factoring company takes on the responsibility of collecting the outstanding invoice payments. These collection services help businesses, particularly small-to-medium enterprises (SMEs), in managing their cash flow effectively.
The Bottom Line
With invoice factoring, businesses effectively transform their credit sales into immediate cash, thereby sidestepping the cash flow challenges often associated with lengthy payment terms.