Running a construction business is not easy, especially when it comes to money matters. Payment delays are common in the industry, and one unpaid invoice can cause a domino effect and cripple a company.
Material suppliers are particularly vulnerable when it comes to payment delays; smaller supply companies often rely on invoice payments to replenish their inventory and maintain steady cash flow. Since payment issues are inevitable in construction, material suppliers tap different financing options, from traditional bank loans to lines of credit, to keep their businesses going.
One of the most common funding options for material suppliers is trade credit. Trade credit is becoming even more popular in the construction market, primarily because it helps businesses get the money that they need without having to acquire more debt.
What is trade credit?
Trade credit – also known as supplier’s credit or mercantile credit – is a form of financing that allows one business to deliver its services to another business before payment is exchanged. It is a short-term financing option, which means that the outstanding payment is expected to be settled within 30 days or in up to 18 months.
In the construction sector, for example, a material supplier can supply materials to a contractor even before receiving payment. The only thing the material supplier has is a promise from the contractor that payment will be sent sometime in the future, maybe in 1 or 3 months, depending on the terms of their agreement.
If you think this set-up sounds a little risky, that’s perfectly understandable. Getting into a trade credit transaction with a contractor, subcontractor, or any other client has its risks, but it also has its advantages and benefits.
One thing to keep in mind is that as the material supplier, you are the party that sets the terms of the trade credit. A trade credit is not something that all contractors can demand from their suppliers – it is typically up to you as the material supplier to decide whether your client is worth offering a trade credit to, how long it should take them to pay you back, and what the consequences are if they fail to honor their promise.
Why offer trade credit to your clients?
Trade credit can be beneficial not just to your buyers but also to your own business. The construction industry is notorious for payment disputes and delays, and a short-term financing option such as trade credit enables construction businesses to help each other keep a steady cash flow.
As a material supplier, offering trade credit to your clients allows you to build good relationships with them. By giving the incentive of delivering supplies before payment is received, you can become the preferred supplier for construction clients.
The reality is most construction businesses, especially the smaller companies, struggle with maintaining a reliable pool of capital. Projects are not always present all year round, so it is in your best interest to build a dependable network of clients to keep your business growing.
When should you offer trade credit to your clients?
Offering trade credit definitely has its risks, so you should not extend this opportunity to just any of your clients without carefully considering the pros and cons of the trade. These are just some of the instances in which a trade credit agreement is worth considering:
1. When you have a good relationship with a client
The risks are relatively lower when you are working with reliable clients who have been diligent in producing payment in the past. If you already have an existing relationship with a client but they happen to be going through some financial troubles, you may want to step in and let them know that you can still provide them the materials so long as they promise to pay you in the near future.
If this client has a history of being dependable, then you are being a good business partner by helping them out. This in turn allows you to solidify your reputation as a reliable material supplier in the market.
Consequently, you may want to reconsider offering a trade credit to clients that you have not worked with before. You may want to do some preliminary research on their credit ratings prior to supplying them the materials without outright payment.
2. When you are trying to grow your small business
Trade credit is a very popular option among small businesses, particularly those that are just starting out and are short on cash themselves. In a perfect world everybody has disposable cash on hand, but material suppliers may not always have available funds for, say, a bulk order from a large client.
In this scenario, offering a trade credit to a major client may be difficult because you do not have enough funding to buy the materials yourself. This is when funding companies like Handle step in. Handle offers suppliers the money that they need to buy materials so they can offer trade credit to their clients.
Instead of passing up the chance to offer trade credit to reputable clients, you can secure Handle’s services and receive the money that you need for this purpose. Handle helps not only with the funding but also throughout the collection process.
3. When you want to stand out among your competitors
Most construction companies go through financial troubles every now and then, so offering a trade option to your clients gives you a leverage to beat your competitors. You stand out by simply allowing your buyers to receive the supplies before they have the funds to pay you.
However, always keep in mind the risks that come with providing such an offer. Your buyers may end up in a deeper financial hole than anticipated, and payment delays and defaults can happen at any time.
Securing the services of a third party can help alleviate these risks. You may want companies like Handle to assess and determine the best terms for your trade credit in order to ensure that you do not suffer a huge financial blow if a major payment delay occurs.
4. When you want to show appreciation to your loyal clients
Offering trade credit does not only help clients who are going through some financial issues – it also allows you to show appreciation to your most loyal and trustworthy clients.
This is another way to establish yourself as a reputable material supplier. By giving your buyers the option of getting into a trade credit agreement, you are giving them a reason to continue running business with you. They may even recommend you to other parties that may need your services.
3 main advantages of offering trade credit to your clients
1. It helps you build good business relationships.
This can’t be stressed enough: In an industry that constantly encounters payment and cash flow issues, being there to assist your clients makes you stand out. Trade credit helps your buyers keep their businesses running during tough financial times, which in turn helps you grow your business and establish a reliable reputation.
2. It shows your clients that you are in good financial shape.
Clients and buyers will know that you are on top of your finances if you are able to take the risk of supplying materials before you receive payment. Not all material suppliers have the financial stability to take such a risk.
Even if you do not have a huge pool of disposable capital, financing services like Handle can give you the capital that you need so you can offer trade credit without having to acquire more debt. Business credit cards and bank loans are also available, but these long-term debts can be more detrimental to your credit rating and financial stability in the long run.
3. It tells your clients that your products are worth buying.
Offering trade credit to your buyers gives the impression that you offer only quality products. You know that your supplies are reliable and are worth the money, which is why you are willing to take the risks that come with trade credit.
Things to keep in mind when offering trade credit
1. Bad credit records of your buyers
Some clients are better than others, so you shouldn’t just offer a trade credit option to any of your clients. If you are working with a small contractor that is just starting out or with a client that you have not worked with before, take some time to do your research.
By doing your research on their reputation and credit standing, you are minimizing the risks of delayed payments and of not getting paid altogether.
2. Possible payment delays
Another thing to consider is your own financial health and how badly you are going to get affected if a client ends up being delinquent. Weigh the pros and cons of the trade credit agreement and always picture the worst-case scenario. Be proactive and make sure that you have the cushion to deal with possible payment delays and issues.
3. Potential penalties
When setting the terms for your trade credit agreement, think of the penalties that you can impose in the event that your buyer does not keep their promise of paying you within the agreed time frame. At the same time, also think of the possible incentives that you can offer to encourage them to pay back as soon as they can.
Most trade credit terms include a price discount if a buyer produces payment before a deadline. Incentives like this help both you and a client get the money that you need, which of course makes for a good business relationship.