Trade credit is a form of short-term financing, wherein a supplier will fulfill an order without requiring cash up front or on delivery. Instead, the supplier will extend trade credit terms specifying time frames within which the payment is due. Though several types of trade credit terms are commonly used, including net10, net30, net60 or net 90, suppliers can specify just about any terms to suit a customer’s particular business model. Businesses often seek different types of trade credit from suppliers in order to conserve cash flow, while suppliers may extend different types of trade credit to help customers best sell their product. Furthermore, many suppliers will also extend trade credit and build in discounts for repayment ahead of the due date specified in the agreement, giving the customer various options depending on whether sales are slow or good.
The common types of trade credit, net10, net30, net60 and net 90, simply mean that the supplier is extending the due date of the payment for products delivered 10, 30, 60 or 90 days, respectively. Some types of industries involving high ticket items, which may have a longer selling cycle, may extend trade credit up to 180 days. Consignment is another option that allows a business to conserve cash flow while offering consumers products in demand. It is not considered a trade credit though, because the supplier still has ownership of products shipped until they are sold. Terms of payment on trade credit, however, usually involve foregoing discounts offered for payment upfront or cash on delivery.
Aside from the common types of trade credit terms extended, many suppliers will still build in discounts in addition to those offered for upfront payment. Referred to as cash discounts, they are often extended if the customer pays at a set date before the final due date. For example, a supplier might extend the following discounts on net60 terms: 20% discount for pay at net10, 15% discount for paying at net30, and 10% discount for paying at net45. Full payment is due at net60 if the invoice is not paid beforehand to take advantage of discounts offered. Discounts offered by suppliers are often used as incentives for businesses to generate sales, but also to afford the business options.
Businesses will often use trade credit terms extended in various ways, depending on how well products sell. If all products have sold within 10 days, the business can exercise the net10 discount and increase profits on the sale of the merchandise by 20%. On the other hand, if sales are extremely slow, the business can simply forgo any discounts and pay according to the terms at net60, while accruing the usual profit.