Trade Credit: Features, Benefits And Example

The commercial credit is a pre-approved money amount issued by a bank to a company, which can be accessed at any time the lending company to help meet various financial obligations you have.

It is commonly used to fund normal day-to-day operations and your payment is often returned once funds are available again. Business credit can be offered on both a revolving and a non-revolving line of credit.

In other words, a business loan is a short-term loan that extends the cash available in the company’s checking account up to the upper credit limit of the loan agreement.

Business credit is often used by companies to help finance new business opportunities or to pay off unexpected debts. It is often considered the most flexible variety of business loans available.

Trade credit is used by frequent borrowers such as manufacturers, service companies, and contractors. The warranty and reimbursement terms are established annually, adapting to particular needs.

characteristics

Business credit is a line of credit offered to businesses that can be used to pay for unexpected operating expenses when cash is not available.

Commercial loans allow borrowers to obtain direct financing approval up to a maximum limit, usually between $ 5,000 and $ 150,000, accruing interest only on the loan fund actually used.

A commercial credit works in a similar way to a credit card: it has a credit limit against which funds can be withdrawn.

For this reason, a business loan is seen as a great loan option for borrowers who have eventual and unpredictable capital requirements.

Businesses with seasonal seasons generally use business credit to help smooth out need cycles in cash flow.

Business credit can also be used to protect against potential overdrafts on your business checking account to reduce concerns about your daily cash flow needs.

How does it work?

A business credit differs from a term loan in that it provides a lump sum of cash up front, which must be repaid over a fixed term.

With a commercial credit you can continue using it and paying it as often as desired, as long as the minimum payments are made on time and the credit limit is not exceeded.

Interest payments are made monthly, and the principal is paid at convenience, although the most appropriate thing is to make the payments as often as necessary.

Business loans with lower credit limits generally do not ask for collateral, such as real estate or inventory.

Credit line

A business line of credit is an agreement between a financial institution and a business, which establishes the maximum amount of a loan that the company can borrow.

The borrower can access the funds from the line of credit at any time, as long as it does not exceed the maximum limit established and as long as it meets other requirements, such as making the minimum payments on time.

As payments are made, more money can be withdrawn, depending on the terms of the loan agreement.

Advantages and disadvantages

Advantage

Commercial loans are designed to meet short-term working capital needs. They are used to finance seasonal needs during peak business periods.

A business loan also helps cover operating expenses that must be paid in the short term. Likewise, to take advantage of discounts offered by suppliers. All this without having to go through the loan application process every time.

Business credit is probably the only loan agreement that every business should have permanently with its bank. Having business credit protects your business from emergencies or stagnant cash flow.

A business credit helps if you are not sure how much credit is needed to meet business requirements. Thus, the idea of ​​flexibility is very attractive, which is its real benefit.

Unlike other types of business loans, business loans tend to have lower interest rates. This is because they are considered low risk.

With the flexible payment programs available, monthly payments can be paid as much or as little as required. This will depend on the agreement previously made.

Disadvantages

The main risk of commercial credit is that the bank reserves the right to lower the credit limit. This will cause serious problems if you are counting on a certain amount when needed.

Some banks even include a clause that gives them the right to cancel the line of credit if they consider that the business is in danger. The business line of credit limits for lending are usually much smaller than a term loan.

With business lines of credit you can borrow more than the business requires or can pay. However, just because it’s approved up to a certain limit, it doesn’t mean that everything should be used.

You have to think twice before applying for a commercial credit greater than what is really needed. By doing this, large debt can quickly build up and put the business in financial trouble.

To negotiate a business loan, the bank will want to see current financial statements, latest tax returns, and a projected cash flow statement.

Example

Suppose XYZ Manufacturing is presented with a great opportunity to purchase, at a deep discount, a much-needed part for one of its manufacturing machinery.

The company is taking into account that this vital piece of equipment typically costs $ 250,000 on the market. However, a supplier has a very limited quantity of the part and is selling it for only $ 100,000. This offer is by strict order of order, while supplies last.

XYZ Manufacturing has a trade loan with its bank for $ 150,000, of which it is paying off a recent loan for $ 20,000. Therefore, he has $ 130,000 available to be used when he deems it convenient.

In this way, you can access the amount of $ 100,000 of your commercial credit with the bank. Thus, you immediately obtain the funds required to buy the piece on sale and thus not miss this opportunity.

After purchasing the piece, at a later date the company will promptly pay the amount borrowed from its commercial credit, with the corresponding interest. You currently still have $ 30,000 of trade credit fully available for any other unexpected operating expenses.

References

  1. Investopedia (2018). Commercial Credit. Taken from: investopedia.com.
  2. JEDC Business Financing (2018). Types of Commercial Business Loans. Taken from: jedc.org.
  3. Fundera (2018). 5 Types of Commercial Loans to Consider for Your Business. Taken from: fundera.com.
  4. Spencer Savings (2018). Know the Different Types of Commercial Loans. Taken from: spencersavings.com.
  5. Entrepreneur (2018). The 7 Different Loans You Can Get as a Business Owner. Taken from: entrepreneur.com.

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