When a business is not paid for weeks after a sale, it is effectively providing short-term financing to their customers, something called “trade credit.” This type of credit can be valuable for small businesses, but the maintenance of timely payment relationships between businesses and their suppliers takes time to achieve and must be managed carefully.
The management of accounts payable and receivable in a timely fashion is one of the most important drivers of small business success. A Harvard Business School study found that acceleration of the “cash conversion cycle” leads to dramatically increased employment growth among small business contractors in the United States.
The availability of trade credit presents a fundamental strategic decision for the small business owner. Many suppliers will offer a percentage discount within a certain payment period: do you turn over funds sooner and take a discount, or wait until the payment period deadline to be able to use the credit for a longer period of time?
The value of each of these options depends on the bigger picture of your business’ financial health and cash flow. For those businesses with lots of cash on hand, the value of a discount may be greater in that it allows you to save more money in the long term: one or two percent aggregated over the course of a year, multiplied by a few different vendors, could mean a difference of thousands of dollars depending on your order volume.
If your cash flow is tighter month to month, the value of retaining the full term until repayment (usually something like 30 days) might mean more to your business. However, as with any credit agreement, be careful not to overstep the terms set out between you and your supplier. Penalties for late payment will dramatically increase the cost of using trade credit, and will erase the benefits that it can confer. If you can’t plan effectively around the longer term schedule, don’t risk damaging your finances and your supplier relationships by way of an over-reliance on trade credit.