An ultimate guide on trade reference: meaning and role for financing
A company’s credit may be checked by a wide variety of third parties, including banks, suppliers, consumers, and insurers. Interest rates, credit limitations, and insurance premiums are just some of the variables that might be informed by a company’s credit file. It is crucial for business owners to understand the trade references definition and how they might be utilized when developing their business credit file, as they are one source of information that can be used to assist compute a business’s credit scores and ratings.
What is a Trade Reference?
So, what does a trade reference mean? A “trade reference” is a report that details the business client’s and the vendor’s respective payment histories together. References in the business world can be provided orally, in writing (in the form of a trade reference letter), or through commercial credit reporting organizations like Dun & Bradstreet, Experian, or Equifax. Credible company references help build solid financial profiles.
When opening a trade credit account with a new supplier, you may be asked to provide the names and numbers of one or more trade references. Before giving credit, a supplier will usually call the client’s previous business partners to find out if they were good to work with. Extending credit is risky since it can cause cash flow issues that can even put profitable businesses out of business. A company may consult industry references to assess the potential for loss associated with a new project or client.
Trade Reference Examples
The following are examples of what might be found in a trade reference:
- Customer identifying information (name of business, address etc.)
- Credit terms (i.e. net 10, net 30)
- Date account opened
- Open AR balance (AR = accounts receivable)
- Past due balance
- Highest previous balance
- DBT (days beyond terms) – current and previous
- Number of late payments
- Credit limit
- Number of credit transactions
Trade Credit Pluses and Minuses
Enables business growth
The two fundamental obstacles to expansion for any worldwide corporation are the inability to pay for goods and services delivered abroad and the accompanying risk of non-payment.
Foreign companies can overcome these challenges with the help of trade finance, a form of short- to medium-term working capital secured by the exported or imported goods or services. Because of this, real estate businesses can expand.
Increased revenue and higher margins
Borrowers can increase their stock order volumes from their final clients with the help of trade financing, thus reaping the benefits of economies of scale.
More cash on hand means that firms may take advantage of the cost savings that come with buying in bulk, improving their profit margins.
Get a competitive edge.
Acquiring items on credit when needed is a competitive advantage for businesses as opposed to competing corporations that may need to front the cash first.
Having a steady supply of goods available even when cash flow is unstable is made possible through trade credit, allowing your organization greater adaptability to market demands and seasonal variations.
Mitigates risk from suppliers
To execute larger contracts, trade finance reduces suppliers’ credit and default risk by using banks or financial institutions to offer additional security. Trade financing disregards the principal borrower and instead concentrates on the trade cycle and the underlying goods, which can apply to any firm of any size or type.
As a result, small enterprises can more easily engage in high-volume commerce, as the funding they acquire will be based on the better credit of their final clients.
There is no need to dip into merchants’ working capital to secure trade finance because this type of financing is specific to current product or service trades. Consequently, this improves liquidity.
When a company has a positive cash flow, it can use that money to reinvest in the company itself, either by purchasing new equipment or implementing a more efficient method of doing business. The result is a more streamlined way to reduce risk, making it easier for businesses to grow quickly.
Easy to arrange
Trade credit agreements are often simple to set up and manage if your company has a solid credit history, can meet a supplier’s standards, and can make consistent payments. It’s quick and straightforward to use because you don’t have to deal with a lot of paperwork or complicated conversations.
Increases your company’s reputation
Showing your organization can reliably make credit payments is an excellent approach to becoming and remaining a valued client. If you have established credit with your suppliers in the past, they may choose to do business with you on a preferential basis.
Product risk or quality disputes
Both consumers and sellers wish to avoid disagreements over product quality. Warranties, agreed-upon service levels, and continuous maintenance are all examples of the types of contractual responsibilities often provided by a vendor. The buyer will also try to reduce the effects of other risks, like carelessness during production or bad weather during shipping. Even after contracts are signed, disagreements might arise over quality. Using inspectors, quality certificates, or trade financing products like bonds might help reduce the possibility of non-performance.
Cash Flow Effect
One obvious consequence of trade credit is that retailers frequently have to wait longer than usual before being paid for their inventory. Selling on credit can be difficult for merchants because it interrupts their cash flow and requires them to cover their own expenses upfront.
Increase in Cost
The interest on trade financing is calculated based on the total value of all transactions that take place under the facility, just like the interest on any other type of loan. Profit margins in trades are crucial to understanding. Financing fees may be factored into trade costs if the company has a firm grasp on its profit margins and operating expenses. It’s also more expensive than specific alternate methods of fund-raising.
Having easy access to credit facilities is a significant benefit of trade credit, but it can also lead to overtrading, which poses its own set of risks for a company.
Trade credit can only be used to generate a small quantity of money; thus, it is not helpful if a business needs a lot of money quickly.
Investigate the Creditworthiness of Customers
The purchaser’s credit history is reviewed by the supplier who provides credit, such as a bank. There is a monetary and time commitment involved. Credit reports for businesses, such as those provided by Dun & Bradstreet, can be expensive to acquire, and checking references is a time-consuming process. To aid in making decisions about extending payment terms, a supplier may need to hire an additional person with expertise in credit analysis.
Financing Accounts Receivable
Since the buyer has been given credit, the seller is responsible for financing these receivables. A seller may have to rely on his own suppliers, draw on his bank’s credit line, or tap into the company’s retained earnings in order to get trade credit. There is an initial investment required for each of these methods.
Possibility of Bad Debts
When sellers offer customers trade credit, some will inevitably default on their payments. This means that a worker has to spend time calling late payers to get their money, and the seller may have to take a loss on the uncollected receivables.
There is a widespread practice across economic sectors of providing purchasers with loan terms. Companies need to provide some sort of payment plan if they want to remain competitive. However, extending credit necessitates taking on extra risk and investing extra effort in keeping track of accounts receivable.
Can trade reference help with financing?
Providing solid trade references might facilitate access to small business funding. On a business loan application, you can be required to list your vendors and suppliers so that your repayment history can be investigated.
Some businesses you do business with on credit will also report your payments to commercial credit bureaus. Building up your company’s credit is as simple as making timely payments on these accounts. For instance, the Paydex score developed by Dun & Bradstreet gives much weight to past trade credit activities. Small business lenders may evaluate an applicant’s application for a loan based on the applicant’s personal credit history, business credit history, business revenue, or a combination of these factors.
Even if your company’s credit isn’t great, you may still be able to do business with some retailers if you give them trade references or let them talk to your current suppliers. This is why it’s common practice for loan applications to request the names of trade references. Building company credit takes more time, so get a head start on the process as soon as possible.
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Note that business credit card applications rarely include verification of personal or professional references. Credit scores are typically used instead to determine approval of credit card applications. While banks rarely ask for trade references when issuing credit, you should always be ready to supply them.
The bottom line
Small business owners should understand trade reference meaning as can add trade references to their arsenal of strategies for improving their company’s credit rating. You shouldn’t, however, just rely on industry standards. Pay attention to everything that can raise your business’s credit score and status in order to get approved for funding, a loan, or a line of credit. Invest in lasting connections and focus on achieving success one sale, one customer, and one business benchmark at a time.