Today, trade credit is an essential tool for companies that want to conquer new markets and build a long-term commercial relationship. Indispensable in certain sectors such as distribution or construction, trade credit does involve various risks, but there are ways to control them effectively.
What is Trade Credit?
Trade credit is an agreement between two companies where a supplier of goods or services accepts a deferred payment from its client.
This agreement does not cost your customer anything: they do not pay any fees or interest.
A trade credit agreement is similar to a 0%-loan – referred to as a “commercial loan” – that you grant your customer when invoicing a product.
When making this agreement, it’s important to define invoice payment terms to provide details about the expected payment and specify how much time your customer has to pay.
Understanding Trade Credit Payment Terms
Trade credit payment terms are the agreed-upon guidelines for when the customer is expected to make the deferred payment. These terms should include the invoice date, the payment due date based on the deferment you extended, an explanation of penalties for late payments, and early-payment discounts if you offer them.
The payment deferments granted generally range from one week to three months and are counted in number of days (7, 10, 30, 60...).
At times, you may set up an accounts receivable discount to your customer to encourage in case of early payment.
Net terms indicate how long the customer has to repay you in full after you issue an invoice. For example:
- Net 30: Customer owes you payment within 30 days of the invoice date.
- Net 45: Their payment is due within 45 days.
- Net 60: Their payment is due within 60 days.
You can offer discounts, based on these net terms, to encourage customers to pay earlier than their net term due date. For example, you could grant a customer a 5% discount for paying within 10 days of receipt of invoice. On the invoice, that discount would look like: 5/10 net 30.
You can also incentivize customers to pay on time by explaining your interest charges for invoices not paid to your net terms. You can also stipulate that payments not received according to net terms will also include debt collection costs. In many countries , such as those like in the European Union, such penalties are statutory and benefit from a regulatory framework. You should check the laws that apply to your contract before setting your payment terms.