Trade credit is a relatively simple concept that can really help small businesses grow. In simple terms, it lets you buy goods or services now and pay later, on agreement with your suppliers. 

This potentially frees up cash flow, keeps operations running smoothly, and lets you invest elsewhere. And suppliers may benefit by building stronger, longer-lasting customer relationships. 

But trade credit comes with risks. Late payments can strain finances for suppliers, while an over-reliance on credit may lead to debt issues for SMBs. Suppliers may also need to charge higher prices to cover their risks. 

For SMBs, understanding the benefits and drawbacks is key. A well-managed trade credit strategy can boost growth, but poor planning can hurt a business.

In this article, we explore the advantages and disadvantages of trade credit for both buyers and suppliers, and some of the industries where it’s best applied.

What is trade credit?

Trade credit is a payment facility granted by a supplier to its customer. Usually seen in B2B transactions, this means that a company can receive goods or services immediately and defer payment until a later date (often between 30 and 90 days).

It’s not dissimilar to buy now, pay later (BNPL) agreements which are now hugely common for consumer purchases. This mechanism lets buyers optimize their cash flow while giving suppliers an opportunity to increase their sales. 

But it can also put companies' financial management at risk if payment terms become too long. And it requires real trust between parties—a failure to pay within the extended deadlines is bad for everyone. 

The advantages of trade credit for buyers

For companies purchasing products or services, trade credit offers a number of strategic advantages.

1. Improved cash flow

By deferring payment, you hold onto cash for longer and can finance other immediate needs. These include:

• Paying salaries
• Investing in business development
• Purchasing other inventory or equipment

You avoid tying up cash in goods or services today, which means you have that same cash available to use elsewhere. Provided you can still pay later, of course. 

2. An optimized cash conversion cycle

In an ideal world, you can resell products before you’ve even paid for them. This speeds up your cash conversion cycle and reduces the need for external financing.

Example:

• A distribution company receives an order for 1,000 units from its supplier with payment due in 60 days. 
• It resells 700 units in 30 days, already generating sales before it has paid the invoice.

This is also known as having negative working capital requirements, and it’s a very good place to be for SMBs selling physical goods. 

3. Easier access to supplies

It’s obviously easier to build your inventory if you don’t have to pay up front in cash. And many suppliers see it as a good marketing tool, or a way to build customer loyalty. 

Either way, you have access to stock without using precious capital.

4. Less dependence on bank financing

Bank loans are often the key financing source for young or small businesses. But they’re hard to attain and the process is long, and many have expensive or difficult terms. 

With trade credit, you're less reliant on bank financing. And at the very least, you give yourself a few months to find capital elsewhere (through sales or alternative financing), before dipping into your precious loan reserves.

The disadvantages of trade credit for buyers

Despite its many advantages, trade credit also brings risks for the companies that benefit from it.

1. Dependence on suppliers

By accepting trade credit, you do become dependent on your suppliers' payment policies. A sudden change (e.g. reduction in payment terms, increase in discount rates) can weaken the company's financial management.

That should obviously never happen during the term of any one transaction. But if you rely on a continued cycle of delayed payments, and then that suddenly becomes unavailable, you’ll have to adjust quickly. 

2. Indirect cost of trade credit

Most trade credit arrangements will come with some form of interest. If the supplier applies a mark-up to compensate for the payment period, you will pay more than necessary for their products.

Example:

• A supplier offers a price of €950 payable within 15 days or €1,000 payable within 60 days.
• By accepting deferred payment, the buyer incurs a cost of 5.3% over two months.

Looking at it the other way around, there’s an early-payment discount if you pay within 15 days. Whether saving 5.3% is worth more to you than having the cash available for 45 extra days will be entirely up to you to decide. 

3. Risk of over-indebtedness

Too much trade credit can lead to an accumulation of debt that the company will find difficult to repay in the event of a sudden downturn in business. Too much debt may also look bad on your financial statements if you’re applying for additional financing in the interim. 

If you have the credit available to pay eventually, there shouldn’t be a major issue. But that’s a big “if” in some cases.  

4. Possible penalties for late payment

There will almost certainly be a penalty built into your agreement if you can’t meet the payment deadline. This could even be determined by law—in France, for example, the law imposes a maximum payment period of 60 days after issue of an invoice, with very few exceptions.

Failure to comply with these time limits will likely come at a financial cost, but also damage to your company's reputation and existing supplier relationships.

The benefits of trade credit for suppliers

For suppliers, granting trade credit is very often an effective way of boosting your business. Here are just four key benefits. 

1. Increased sales

The primary reason suppliers offer trade credit is to boost sales. If you make it easier and more attractive for customers to buy from you, they probably will (and at greater volume). 

2. Competitive advantage

Offering attractive payment terms also helps you stand out from competitors who are stricter on payment terms. Word gets around, and other buyers will follow their peers who have had great experiences buying from you. 

3. Strengthening customer relations

When a company grants trade credit to a customer it trusts, it builds a solid, long-term relationship based on trust and cooperation. Offer convenient terms which buyers know and love, and of course they’ll keep coming back in future. 

4. Possibility of discount rates

A supplier can offer discounts to encourage customers to pay earlier, thereby accelerating cash flow.

Example:

• Payment within 15 days = 2% discount
• Payment within 60 days = full rate

The disadvantages of trade credit for suppliers

Just as we saw for buyers, there can be downsides to trade credit for suppliers. Here are just four.

1. Risk of non-payment

Granting trade credit means trusting the buyer. If that buyer runs into financial difficulties, you run the risk of being paid late, or never getting paid at all. 

2. Negative impact on cash flow

Payment at 60 or 90 days lengthens your cash conversion cycle, as you have to continue financing your own expenses while waiting to be paid. This may not be the optimal working capital situation for your business, even if it potentially increases sales. 

One solution to this is invoice factoring (sometimes also known as assignment of receivables). Rather than waiting 60 days to be paid, you can essentially sell these unpaid debts to a third party. If the cost of invoice factoring is lower than the amount you gain from offering longer payment terms, this arrangement is a clear win. 

Want to use your customer invoices for short-term financing? Defacto offers fast, flexible funding using your receivables. Learn more here. 

3. Management complexity

Managing deferred instalments requires rigorous monitoring to avoid delays and payment defaults. The more customers there are on trade credit, the more complicated it is to manage accounts receivable.

4. Cost of collection

In the event of late or unpaid invoices, you’ll have to take recovery actions. Chasing clients can be lengthy and costly, especially if you’re not particularly skilled or experienced at it. 

This is another reason why some businesses use factoring. Factors tend to have a strong history of collections, and they take this additional stress off your hands. 

Sectors where trade credit works well

Trade credit is a widespread practice in B2B, but its effectiveness depends very much on the sector of activity, the structure of sales cycles and the level of customer risk.

Here are a few industries that tend to use trade credit to great effect. 

• Distribution/retail: Distributors buy in volume and need to defer payments to align their disbursements with sales. Trade credit is a common tool, with a clear contractual framework.

• Food industry: Longer payment terms are a standard feature of the industry. Players often have reliable data on the solvency of buyers (cooperatives, central purchasing bodies), which limits the risk of non-payment.

• Light industry or consumer goods: When production cycles are short and margins relatively stable, suppliers can easily absorb a 30- or 60-day payment term.

• Recurring agencies & service providers: In long-term relationships with professional clients (marketing, IT, HR), trade credit is often built into framework contracts.

Sectors where trade credit can be a problem

While there’s potential for trade credit to work well in most industries, here are a few that often run into issues. 

• Construction: payment terms are long, there are many intermediaries, and disputes are frequent. The risk of non-payment is higher, especially at the end of a project.

• Heavy industry (aeronautics, nuclear, defence): Production cycles can last 120-180 days, and even far higher. Granting trade credit in this context can expose suppliers to prolonged cash flow pressures, especially if they are at the end of the subcontracting chain (tier 3 or 4).

• Start-ups or young companies: Their business model is still unstable and their cash flow can be tight. Granting trade credit without solid guarantees significantly increases the risk of non-payment.

• Export/international markets: Exchange rate risk, regulatory differences and collection difficulties make trade credit more risky outside France or the EU, especially without credit insurance.

Striking the right balance in trade credit and optimizing cash flow

To take advantage of trade credit without jeopardising your finances, here are a few tips:

For buyers

• Negotiate payment terms to maximize cash flow, but keep within manageable limits.
• Compare hidden costs (discounts, surcharges) before agreeing to deferred payment.
• Anticipate due dates to avoid an accumulation of debts.

For suppliers

• Assess the creditworthiness of customers before granting trade credit.
• Use invoice financing to recover cash immediately and avoid cash flow tensions.
• Set late payment penalties to encourage prompt payment.

How Defacto can help you optimize your cash flow

Trade credit is a powerful lever, but it can also weaken your business if payment terms are too long or you fail to manage them effectively. Through no real fault of your own, you can wind up in tricky cash flow situations, particularly as a supplier with generous payment conditions.

Are you a supplier waiting 60 days (or more) to be paid? With Defacto, you can finance your invoices immediately and secure your cash flow without waiting.

Test your eligibility in 27 seconds and optimize your cash flow cycle today.