In this article
Talk to our experts- Trade credit
- Trade credit is credit one business extends to another when it sells goods or services on account and lets the buyer pay at a later date, on agreed terms such as net 30 or net 60. For the buyer it is a source of short-term financing, because it can buy supplies without paying for them immediately.
How it works
The supplier delivers first and the buyer is given time to pay after receiving the goods. The terms set two things:
- The payment window. Net 30 or net 60 means the net invoice amount is due in full within 30 or 60 days.
- Any early payment discount. "2% 10, net 30" gives the buyer 2% off for paying in full within 10 days of the invoice date.
Suppliers grant it to customers with a reasonable amount of financial standing and goodwill. By tracking who pays and when, a supplier can spot problems developing and raise or lower the amount of credit each account gets.
A distributor can receive trade credit from its own suppliers on shorter terms than it extends to its customers, which can put it in a disadvantageous position.
The supplier is exposed to losses if a customer goes bankrupt and never pays for goods already delivered.
Example
A distributor buys $8,000 of stock from a manufacturer on net 30. The same day, it sells that stock to a contractor for $10,000 on net 60.
- Day 30. The distributor pays the manufacturer $8,000.
- Day 60. The contractor pays the distributor $10,000.
- The gap. From day 30 to day 60, the distributor funds $8,000 from its own cash.
Trade credit vs cash in advance
A 2020 Federal Reserve Board discussion paper (International Finance Discussion Papers 1303) models the choice between them. In the model, the seller ships first and the buyer sells to a final consumer later. Because of that time gap, firms need to agree on payment terms. The paper gives two options:
- Cash in advance. The buyer pays before receiving the goods.
- Open account. The buyer pays after delivery, so the seller extends trade credit.
The paper describes a commitment problem: a buyer may not pay after receiving goods on trade credit, and a seller may not deliver after being paid cash in advance. It notes a third form used only in international transactions, the letter of credit, where banks help resolve that problem for a fee. Using data on Chilean export transactions, the paper finds that trade credit use increases with relationship length: firms often switch from cash in advance to trade credit, but rarely switch back. The paper also reports that in 2019, U.S. non-financial firms had about $4.5 trillion in trade credit outstanding, equal to 21 percent of U.S. GDP.
Counting the days and the cost of a discount
- Start date. One definition counts the days from the date the goods are dispatched or the service is completed. Shopify B2B starts all of its terms from the day the order is placed, so the agreed terms set the start date.
- Skipping the discount. On a $10,000 invoice at 2% 10, net 30, paying within 10 days of the invoice date takes $10,000 x 0.02 = $200 off, so the buyer pays $9,800. If it pays the full $10,000 on day 30 instead, those 20 extra days of credit cost $200, about 2.04% of the $9,800.
On Shopify
On Shopify, net terms for business buyers are B2B payment terms, which define how long a company has to pay for an order. Shopify B2B is available on all plans.
- Who gets terms. You set them per company location, for all locations in a company, or in bulk.
- Which terms. Net 7, 15, 30, 45, 60 and 90, or due on fulfillment. All terms start from the day the order is placed. An individual draft order can also take a fixed date.
- Reviewing before accepting. To review orders before you accept them, you can require a company location to submit all orders as drafts, so its buyers see a Submit for approval button at checkout.
- Collecting. Unpaid orders past their terms show as Overdue in customer accounts, and payment isn't captured automatically.
How Uncap helps
Uncap has configured net terms workflows for manufacturers and distributors across a wide range of buyer programs and ERP environments. Our guide to Shopify net terms covers the buyer experience at checkout and the back-office collection process.
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Frequently asked questions
What is trade credit in simple terms?
A supplier lets a business customer buy goods or services now and pay for them later. The supplier delivers first and the buyer pays the invoice within an agreed number of days.
How does trade credit work?
The supplier sets terms such as net 30, ships and invoices, and the buyer pays by the due date. Tracking who pays and when lets the supplier adjust each account's credit.
What are the downsides of trade credit?
The supplier is exposed to losses if a customer goes bankrupt and never pays. A buyer that skips an early payment discount pays more: on a $10,000 invoice at 2% 10, net 30, paying on day 30 instead of within 10 days costs $200 more.
