Commercial credit is the single largest source of business financing in the world, exceeding even bank loans. Without business credit, the world's business economic system would not exist.
During times when the industry has been in a high-growth phase, credit has been more widely available and lenders have relaxed their lending criteria to stay competitive.
However, in the current economic climate, providers have tightened their lending criteria to reflect the increased risk of business failure.
So how can SMEs get the level of trade credit they need? When applying for a trade credit account, applicants must first fill out credit application forms. This will form the basis of an initial credit assessment.
SMEs need to understand that suppliers providing trade credit are investing in their business. One thing suppliers will look for, particularly when dealing with recently established companies, is the amount of share capital invested by the owners.
With limited liability, why should a supplier offer credit terms to a company with only £2 share capital? SMEs are more likely to be granted credit if they show a commitment to their businesses and make decent equity investments from the start.
As a guideline, £5,000 equity for a start-up should provide suppliers with a degree of comfort. This should increase as the business grows.
Once a credit line with the supplier has been established, it is vital that payments are made on time. Suppliers are much more likely to increase lines of credit if a good trading history has been built up.
But if payments are not made on time, credit lines may be reduced or withdrawn.
The negative effect of late payments does not stop there. Nearly all suppliers that offer credit terms will cover their risk with credit insurance.
Resellers should recognise that details of late payments will have to be reported to insurers.
They should realise that the same credit insurer may be insuring more than one of their suppliers, which may cause their insurance levels to be reduced as a result of late payment, and in turn credit lines may be cut.
Good relationships between suppliers and resellers are essential. Distributors are more likely to extend lines of credit if they are supplied with up-to-date information.
By paying suppliers on time, SMEs can create a mutually profitable trading relationship.
Alan Norton is head of intelligence at Graydon.
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