A business trade credit agreement involves one entity agreeing to supply goods to another party without requiring the purchaser to pay for those goods upon receipt. In a standard business trade credit arrangement, the buyer has a grace period of at least 10 days before payment is due and in some instances, weeks or months may pass before a buyer actually has to pay for the goods. Many business entities use such arrangements in order to keep short-term inventory costs low.
Generally, a start-up business cannot enter into a trade credit agreement because most business owners are reluctant to extend credit to entities that do not have an established history of managing debt. New businesses are normally funded with the owner's own money but eventually the firms that supply these companies may agree to a credit arrangement. Within the retail world, certain types of goods and services are primarily bought at particular times of the year. Retailers normally buy inventory during the low season but a business with minimal cash reserves may lack the resources to buy sufficient inventory to cash-in on the high season. By entering into a business trade credit agreement, a business can acquire new inventory and wait until those goods have been sold before paying back the supplier.
Trade agreements are effectively loan arrangements and like any lenders, businesses that extend credit normally conduct credit checks. In many nations, certain agencies gather information pertaining to the past borrowing habits of consumers and commercial entities. These firms also gather financial information related to entities and people and use this information to create credit reports. Typically, these reports contain a score and the most creditworthy borrowers receive high scores while high-risk borrowers receive low scores. In most instances, a business entity will obtain a purchaser's credit report before deciding whether to approve or deny a business trade credit agreement.
On some occasions, creditworthy individuals and businesses can run into financial problems when unforeseen emergencies arise. A supplier could lose money as the result of a business trade credit agreement if the other party proves unwilling or unable to settle the debt. To alleviate this risk, many businesses purchase trade credit insurance policies. In return for a monthly or annual purchase premium, insurance companies insure suppliers against losses caused by trade agreements. Such policies are not widely available in all places and the willingness of business owners to extend credit is often directly tied to the availability and cost of credit insurance policies.