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Building a strong credit profile is essential for businesses to establish credibility and access financing options. One powerful tool in this process is trade references. In this comprehensive guide, we will explore the advantages and disadvantages of trade credit, how to obtain trade references, and the impact they can have on financing opportunities. By understanding the importance of trade references, businesses can take proactive steps to strengthen their credit standing.
Advantages of Trade Credit
Trade credit offers several advantages for businesses:
1. Easy Access to Credit
Compared to small business loans, trade credit is often easier to obtain. By establishing relationships with suppliers or vendors, businesses can purchase goods or services and defer payment until a later date, typically within a specific timeframe known as “net terms.” This allows businesses to improve cash flow and maintain a steady supply of necessary resources.
2. Improved Cash Flow
Trade credit can help businesses manage their cash flow effectively. Instead of paying upfront for goods or services, businesses can negotiate payment terms that align with their revenue cycle. This flexibility can be particularly beneficial for businesses experiencing seasonal fluctuations or temporary financial constraints.
3. Building Business Credit
Maintaining excellent trade references contributes to building a strong business credit profile. When businesses consistently make timely payments to their suppliers or vendors, this positive payment history can be reported to commercial credit reporting agencies, such as Dun & Bradstreet, Experian, or Equifax. These agencies track and evaluate business payment history, which can ultimately result in a higher credit score and increased credibility with lenders.
Disadvantages of Trade Credit
However, trade credit also has some disadvantages that businesses should be aware of:
1. Lower Credit Limits Initially
When businesses first establish trade credit, they may be granted lower credit limits. This is because suppliers and vendors are cautious when extending credit to new customers. As businesses build a track record of timely payments, their credit limits may increase over time.
2. Limited Purchasing Options
Trade credit is typically limited to specific suppliers or vendors. This can restrict businesses’ purchasing options and potentially limit their ability to negotiate favorable terms. It is important for businesses to carefully select suppliers and vendors that align with their needs and provide competitive pricing.
3. Limited Impact on Business Credit
While trade references can contribute to building business credit, they may not be the sole factor influencing credit scores. Other considerations, such as time in business, revenues, and personal credit scores, also play a significant role in lenders’ evaluations. Therefore, businesses should focus on building a comprehensive credit profile rather than relying solely on trade references.
Obtaining Trade References
To obtain trade references, businesses should follow these steps:
1. Establish Business Relationships
Businesses can acquire trade references by conducting transactions with suppliers or vendors that offer “net terms” or credit arrangements. These relationships are typically formed by purchasing goods or services and deferring payment until a later date, as specified in the agreed-upon terms.
2. Request Written or Verbal Trade References
Suppliers or vendors may request trade references from existing business relationships as a way to assess a company’s payment history. These trade references can be provided in the form of written trade reference letters or through verbal verification with existing suppliers.
3. Leverage Business Credit Reports
To evaluate a business’s payment history, suppliers or vendors may also check business credit reports. It is essential for businesses to establish a business credit history and ensure that their payment records reflect positively. This can be achieved by making timely payments to creditors and maintaining a good credit utilization ratio.
4. Consider Net 30 Vendors for New Businesses
New businesses, with limited credit history, can start by seeking out suppliers or vendors that offer “net 30” terms or similar credit arrangements. These vendors are often more open to working with businesses that are less than two years old or do not have an established business credit record. A list of easy net 30 vendors can be found here.
5. Build Relationships with Existing Suppliers
Existing businesses should begin by reaching out to their current suppliers or vendors to inquire about credit options. It is crucial to monitor business credit reports to identify which suppliers report payment history, as this can positively impact the business’s credit profile. Nav.com offers free business credit monitoring services to help businesses stay informed.
6. Fulfill Purchase Requirements
Some suppliers may require businesses to make a certain number of purchases before extending credit. This is particularly common for new businesses that have not yet established a credit history. By fulfilling these purchase requirements, businesses can establish trust and build a foundation for future credit transactions.
The Role of Trade References in Financing
Trade references can play a significant role in qualifying for small business financing. When applying for business financing, lenders may request the names of vendors or suppliers to verify payment history. Positive trade references demonstrate a business’s ability to manage credit responsibly and can increase the likelihood of securing favorable financing terms.
Additionally, some suppliers report payment experiences to business credit reporting agencies. On-time payments on these accounts can positively impact a business’s credit score. For instance, Dun & Bradstreet’s Paydex score heavily weighs trade credit experiences. A strong business credit profile, along with factors like time in business, revenues, and personal credit scores, can influence lenders when evaluating loan applications.
While trade references may not be checked when applying for business credit cards, personal credit scores typically play a more significant role in the evaluation process. Banks may not frequently request trade references when extending credit, but businesses should be prepared to provide them when applying for financing.
What to Include in a Trade Reference
A trade reference typically includes the following information:
- Customer identifying information, such as the name and address of the business.
- Credit terms, specifying the agreed-upon payment timeframe, such as “net 10” or “net 30.”
- Account opening date, indicating when the business relationship was established.
- Open accounts receivable (AR) balance, representing the outstanding amount owed.
- Past due balance, highlighting any overdue payments.
- Highest previous balance, indicating the highest amount owed in the past.
- Days beyond terms (DBT), reflecting the number of days a payment is overdue compared to the agreed-upon terms.
- Number of late payments, documenting the frequency of delayed or missed payments.
- Credit limit, specifying the maximum amount of credit extended to the business.
- Number of credit transactions, indicating the frequency of credit utilization.
The Importance of Providing Trade References
Businesses should proactively provide trade references to their partners for several reasons:
1. Extending Credit to Customers
When businesses provide goods or services without immediate full payment, they are effectively extending credit to their customers. In such cases, businesses may be asked to provide trade references to assess their customers’ payment history. Accommodating these requests helps businesses and other companies mitigate potential credit risks.
2. Ensuring Timely Payment
By requesting trade references, businesses can verify their customers’ payment history and assess the level of risk involved in extending credit. It is important to have customers fill out credit applications to screen their credit information and determine the appropriate level of credit to extend. Checking their business credit files can provide additional insights and help businesses gauge their customers’ creditworthiness.
3. Reporting Payment Experiences
Businesses may further consider reporting their customers’ payment experiences to commercial credit bureaus, such as Dun & Bradstreet, Equifax, Experian, or the Small Business Financial Exchange. By reporting to these agencies, businesses incentivize their customers to make timely payments and help them build their own business credit profiles.
Understanding the Relationship Between Trade References and Trade Credit
Trade references and trade credit are closely intertwined. Trade credit refers to the arrangement where a business allows another business to purchase goods or services without immediate payment. The trade reference, on the other hand, reflects how the customer manages that credit. The payment history established through trade credit transactions determines the nature of the trade reference provided by suppliers or vendors.
Trade References and Personal Credit
The good news is that businesses do not necessarily require excellent personal credit to establish trade credit. Some suppliers or vendors do not check the business owner’s personal credit reports at all. In some cases, they may perform a “soft check” to rule out extremely low personal credit scores. This means that businesses can secure credit with suppliers while concurrently working on improving their personal credit.
Conclusion
Trade references play a crucial role in building business credit and accessing financing opportunities. By establishing strong relationships with suppliers or vendors, businesses can obtain trade references that reflect their positive payment history. Timely payments and responsible credit management contribute to a robust business credit profile, which lenders consider when evaluating loan applications. By understanding the importance of trade references and actively managing credit relationships, businesses can enhance their credit standing and unlock new growth opportunities.
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