What is a trade line of credit

Trade credit: characteristics, advantages and disadvantages and example

Trade credit is a pre-approved amount of money that is spent by a bank on behalf of a company and that the borrowing company can access at any time to meet the various financial obligations it has.

It is typically used to fund ongoing business operations and is often repaid when the funds become available again. Commercial loans can be offered in both a revolving and a non-renewable line of credit.

That is, a business loan is a short-term loan that extends the cash available in the company's checking account up to the credit limit of the loan agreement.

Trade credits are often used by companies to fund new business opportunities or to pay off unexpected debts. It is often considered to be the most flexible type of commercial loan available.

Trade loans are used by common borrowers such as manufacturers, service companies, and contractors. The guarantee and reimbursement conditions are set annually and adapted to the respective needs.

properties

Trade credit is a line of business credit that can be used to pay unexpected operating expenses when cash is not available.

Commercial loans allow borrowers to obtain direct financing approval up to a maximum amount typically of $ 5,000 to $ 150,000 with interest only on the loan fund actually used.

A trade loan works in a similar way to a credit card: there is a credit limit against which funds can be withdrawn.

For this reason, a commercial loan is considered an excellent loan option for borrowers who have conditional and unpredictable capital requirements.

Seasonal businesses typically use trade credits to meet cash flow needs.

Trade credits can also be used as a hedge against possible overdrafts on the trading account to alleviate concerns about daily cash flow needs.

How does it work

A commercial loan differs from a term loan in that it provides a single advance payment that must be repaid for a limited period.

With a trade loan, you can keep using it and paying as many times as you want, as long as you make the minimum payments on time and don't exceed the credit limit.

Interest payments are made monthly and the principal is paid at will, although it is more reasonable to make the payments as often as possible.

Commercial loans with lower credit limits generally do not require guarantees such as real estate or inventory.

Credit line

A trade line of credit is an agreement between a financial institution and a company that sets the maximum amount of a loan that the company can borrow.

The borrower can access funds at any time via the credit line, provided that they do not exceed the specified maximum limit and meet other requirements, such as: B. the punctual execution of the minimum payments.

When payments are made, more money can be withdrawn according to the terms of the loan agreement.

Advantages and disadvantages

advantages

Business loans are designed to meet short-term working capital needs. They are used to finance seasonal needs in times of increased business activity.

A business loan is also used to cover the operating costs to be paid at short notice. Take advantage of the discounts offered by suppliers. All of this without having to go through the loan application process every time.

Commercial loans are probably the only loan agreements any business should get into with their bank on a permanent basis. A trade loan protects the company from emergencies or stagnant cash flow.

A business loan will help if you are not sure how much credit will be needed to meet the business needs. So the idea of ​​flexibility is very attractive, which is its real advantage.

Unlike other types of commercial loans, commercial loans tend to have lower interest rates. This is because they are classified as low risk.

With flexible payment programs, monthly payments can be paid as much or as little as required. This depends on the agreement made previously.

disadvantage

The main risk of trade credit is that the bank reserves the right to reduce the credit limit. This can cause serious problems if you are counting on a certain amount when needed.

Some banks even have a clause authorizing them to terminate the line of credit if they believe the business is in jeopardy. The limits of the commercial line of credit are usually much lower than those of a term loan.

Commercial lines of credit allow you to borrow more than the company needs or can pay. However, just because it's allowed up to a certain limit doesn't mean that everything should be used.

You need to think twice before applying for a business loan larger than what is really needed. That way, you can quickly create a large debt and get the business into financial trouble.

In order to negotiate a commercial loan, the bank wants to see the latest financial statements, the latest tax returns, and a planned cash flow statement.

example

Let's say that XYZ Manufacturing company has a great opportunity to purchase a much-needed piece for one of their manufacturing machines at a huge discount.

The company takes into account that this important device is typically $ 250,000 in the market. However, one supplier has a very limited quantity of the piece and sells it for only $ 100,000. This offer is in strict order until existence is exhausted.

XYZ Manufacturing has a $ 150,000 trade loan with its bank, of which it recently paid a $ 20,000 loan. Because of this, there is $ 130,000 available to use if necessary.

This will give you access to the $ 100,000 amount of your business loan at the bank. In this way, it immediately receives the money it needs to buy the item on offer and thus not lose this opportunity.

After purchasing the piece, at a later date, the company punctually pays the amount borrowed from its trade loan with the corresponding interest. Currently, there is still $ 30,000 in trade credits available for any other business expenses that arise unexpectedly.