How Trade Credit Impacts Supply Chain Finance Strategies

Trade credit is still one of the most reliable and oldest methods used to run a business. It involves a situation where a supplier permits a buyer to acquire goods or services but pays for them later. There is no payment at the point of sale. Instead, payment is made after some time, which could be 30, 60, or even 90 days. In the modern-day scenario, Trade credit has become important in a world where supply chain finance has become a major revenue stream for companies.

Every supply chain finance strategy relies heavily on cash flow, timing, and any predetermined risk management. Each of the trade credit components resembles these characteristics of synchronization.

What is Trade Credit?

Trade credit is the credit given to a buyer by a supplier, depending on the buyer’s promise to pay later. This serves as a safety net as it keeps the businesses up and running even when immediate cash is unavailable. It buys time for buyers to sell the goods or use the services and make profits before they need to pay their bills. As for suppliers, extending trade credit can foster stronger customer relationships but comes with a price.

Trade credit is essential to managing a business’s working capital. Both purchasers and merchants utilize it to manage their cash inflows and outflows better. For buyers, it manages to suspend cash payments and, thus, can be considered as a short-term credit facility extended by the sellers.

How Trade Credit Affects Supply Chain Finance

Trade credit affects certain domains of supply chain finance. It aims to optimize working capital availability throughout the supply chain by ensuring all participants are provided with funds when required.

To begin with, trade credit assists firms in managing their liquidity. With trade credit, buyers do not have to liquidate cash or tie up cash immediately, which can later be used for investment purposes. This leads to positive cash flow management.

Trade credit also assists businesses in managing financing costs. Businesses and companies that rely heavily on trade credit are less likely to need bank loans or other costly financial aid. On the other hand, suppliers bear the cost of delayed payments. To address this, they sometimes anticipate a more immediate payment for their invoices, which is referred to as supplier financing or invoice factoring. In this, a supplier sells their receivables to a third party.

Thirdly, trade credit can impact risk concerning the supply chain. A buyer not paying on time poses a risk for the supplier not receiving payment. Such a risk has to be managed with great care. To mitigate this risk, strong relationships, positive credit check results, and sometimes supply chain finance programs are utilized.

Lastly, trade credit affects power in negotiations. Creditworthy buyers are often able to negotiate more favorable contract terms, such as extended repayment periods. This impacts the cash flow throughout the supply chain.

Trade Credit and Working Capital Optimization

Working capital optimization is one of the goals set within supply chain finance strategies. Trade credit helps in this area by providing added flexibility to companies. Buyers having more time to pay translates to better cash inflows and outflow scheduling.

On the supplier side, however, extending trade credit translates to their cash being tied up until payment is received. If many buyers are given long payment terms, it becomes increasingly challenging to support operations. There are always suppliers who are willing to buy these delays, but are forced to manage supporting buyers with the payment delays heavily.

Most companies now adopt supply chain finance options, such as reverse factoring, to alleviate this pressure. In reverse factoring, the buyer collaborates with a bank or finance entity that pays the supplier ahead of time while the buyer enjoys longer payment periods. This is advantageous for both the supplier and the buyer.

Risks Involved with Supply Chain Finance Trade Credit

Despite offering significant advantages, trade credit also comes with risks that impact the supply chain finance approach. The supplier stands to suffer if a buyer goes bankrupt or defaults on payment, which is a key risk. This could lead to the collapse of numerous interconnected companies within the ‘supply chain’. Effective credit management controls and underwriting may help mitigate some of these risks.

Another leading risk concerns the potential strain on cash flow. A supplier may find it difficult to cover the costs of certain unfinished work if too much cash is tied up in unpaid invoices, such as the supplier’s ongoing billing cycles. This would hinder the function of the entire supply chain.

How Other Companies Respond?

Businesses are becoming more aware of the influence trade credit has on their supply chain finance strategies. Technology plays a vital role in operations. A large proportion of businesses are adopting financial platforms for tracking payment processes, monitoring credit risk, and prioritizing payments if necessary. These payment methods give access to insights as they occur, which improves decision-making when granting or utilizing trade credit.

Firms are putting a lot of effort into managing the relationship between the buyer and seller. This relationship could be well managed so that it offers the opportunity for payment flexibility that benefits both sides. Effective and informative dialogue regarding payment obligations and financial requirements is important.

To maintain a healthy supply chain, a good number of producers are implementing new kinds of supplier financing. Some are providing discounts for customers who pay early, which is referred to as dynamic discounting. Others are utilizing blockchain to create clear records of transactions, which is meant to prevent fraud and enhance payment speed.

Conclusion

Every business is affected by trade credit, which impacts each component of the supply chain finance. It aids their working capital, cash flow, and business partnerships. However, it is equally important to address the risks that come with it. Credlix and similar platforms offer quick and dependable solutions for supply chain financing, further enhancing efficiency. With Credlix, businesses can free up working capital, pay suppliers promptly, and manage trade credit more efficiently. The entire supply chain can be improved, and business growth can be fostered by doing so.