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8 Hidden Costs of Trade Credit

Topics: Finance, Management, Sales/Marketing & Customer Service

When you’re selling a large ticket item or routinely selling to business customers, your customers might not have the cash available to purchase immediately. Extending trade credit is often what large enterprises turn to in order to solve this problem, though this solution can be costly. 

What Are Credit Terms? 

When an enterprise wants to make more sales, they’ll often allow businesses to pay within a certain time frame – usually 30, 60, or 90 days. In other words, they will extend trade credit. This agreement between the seller and the buyer is known as the “credit terms.”  

While extending trade credit is a great way to make more sales, it brings with it a lot more costs, especially when you’re doing it in-house.

Here are just a few of the costs you can associate with offering financing, or, in other words, extending trade credit:

1. Invoicing Software & Databases

When you’re thinking about the costs associated with extending capital to your clients, it’s easy to forget about the support system you’ll need to be able to do it. Invoicing software has been a huge help to companies looking to offer net 30 or other forms of financing, but it still costs your company money — usually hundreds of dollars a month.

Trade Credit Software Cost-01

On top of that, you’ll often need additional software, such as database software, to support your invoicing software. This can add additional expenses.

Experian Pricing

2. Accountant's Salary

If you have invoices going out, it doesn’t matter how great your invoicing software is; you’ll still need someone to run it. Even if it’s combined with other accounting tasks, you’re still looking at thousands of dollars a month worth of manpower to deal with accounts receivable. 


Image Source: Glassdoor

3. Credit Insurance

Businesses trying to guard their accounts receivable against too many bad debts turn to insurance companies to help protect against these losses. This kind of insurance is called credit insurance, and it can prove invaluable when trying to create a steady cash flow. Just like anything in business, though, it’s not free. Insurance companies will usually be paid based on a whole turnover basis. This can add up and increase the cost of extending payment terms. Visit Allianz Trade to learn more about trade credit insurance costs.

4. Uncollectable Debt

A big, obvious cost of extending trade credit to your customers is the uncollectible debt you will have. It can be frustrating to provide a service or product to a customer and not receive payment for it.  According to Atradius, late payments in 2021 affected 47% of the total value of all B2B credit sales (US: 50%, Mexico: 45%, Canada 48%).

Many companies turn to collection agencies to help get their payments, but even then, you’re going to be paying for their services. This is a cost of trade credit that you must strive to keep as minimal as possible. 

5. Cost of capital

Another cost of trade credit is just no longer having that capital in your hand. When you extend $1000 worth of trade credit, that’s $1000 you don’t have to work with. One way to find out exactly how much this is costing is figuring out your weighted average cost of capital, or your WACC. 

When your business trade credit terms are net 60 or net 90, it can be easy to feel the cost of not having that cash on hand.

6. Factoring

Often, companies that have a large number of accounts receivable but need cash immediately will sell their accounts receivable to a financing company. This process is called factoring. This can be a great way to boost your cash flow, but it doesn’t come cheap.

factoring-rates-structureSource

Factoring can carry a high cost, largely because when you sell your accounts receivable, the risk goes along with it. While cash on hand can help you take advantage of opportunities that will help your company grow, you need to be careful to make sure your opportunity cost is greater than the cost of factoring.

7. Sales Department Salaries

A lot of companies will use their sales departments to reach out to their clients in order to collect late payments. This makes perfect sense, right? The salesperson already has a relationship with the client, and it would be easier for them to negotiate the debt payment…

…But here’s the issue.

Every hour your sales team spends chasing down debt is an hour spent not making a sale. If you’re constantly chasing the money you’re already owed, you’re not chasing the money you have yet to make. So while your immediate cash flow may improve, you're sacrificing your future cash flow.

Sales doing collections

8. Early Payment Discount 

One way companies incentivize customers to pay on time is with a discount, usually a 1/10 or 2/10 discount. What this means is that if the customer pays in the discount period, which in the case of 1/10 or 2/20 is in the first 10 days, they’ll get either a 1 percent discount or a 2 percent discount.

While this is a great way to get paid quicker and more consistently, you have to remember this is still a cost of extending trade credit. If you required people to pay upfront, you would not have any early pay discount, and you would receive that money immediately.

Other Options

A lot of companies do in-house financing and succeed at it, generating sales while also collecting payments. Recently, however, there has been a trend toward using third parties to facilitate the financing. 

Companies like Apruve have developed platforms to manage credit while also managing invoicing and accounts receivable. 

When deciding which trade credit terms and processes are right for your business, consider the cost of trade credit and also the cost of extending payment terms.  Taking all the costs into account will allow you to make more sales, growing your company towards the future. 

Are you looking for a way to automate your B2B company's credit management and mitigate risk when extending trade credit to new customers? Apruve can help. With Apruve, you can easily extend risk-free credit to your customers worldwide, and make sure you get paid within days. Learn more about Apruve's credit network or contact Apruve’s specialists to sign up for a demo today!

Net terms accounts receivable

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ABOUT APRUVE

Apruve enables large enterprises to automate long-tail credit and A/R so you can stop spending 80% of your time and resources on 20% of your revenue. We partner with each of our customers to solve their unique credit, payment, and accounts receivable challenges and build the right credit solutions for your markets, customers, and goals. 

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