Trade credit is credit that one business extends to another by delivering goods or services and accepting payment later. It is one of the most widely used forms of business financing, even though no lender is involved.
How it works in factoring
From the buyer's point of view, trade credit is an account payable: free short-term financing as long as it pays within terms. From the seller's point of view, it is an account receivable: cash the seller has earned but not yet received.
Factoring sits on the seller's side of this relationship. When a business extends trade credit on net 30, 60 or 90 terms, it often needs cash before the customer pays. Selling those receivables to a factor converts the trade credit it has extended into immediate working capital.
Illustrative example: A packaging maker sells $25,000 of boxes to a food producer on net 45 terms. The packaging maker needs to buy raw materials for the next order now. Factoring the invoice lets it fund that purchase without waiting 45 days.
Trade credit decisions also shape factoring outcomes:
- Customers who receive credit without proper checks can become slow payers or bad debts
- Generous terms extend the time factored invoices are outstanding
- Credit limits set by the seller should line up with what the factor will fund
What to check
- Run credit before offering terms to a new customer
- Set clear limits and terms in writing
- Consider trade credit insurance or non-recourse factoring for large exposures
Offering trade credit is often necessary to compete, but it should be managed as carefully as any loan.