Trade Credit is an important lifeline of running a successful business. Allowing payment on credit to your customers and paying in advance to your vendors are some of the usual ways of working of a business.
Trade finance is a significant way of how businesses are conducted in the B2B (Business to Business) universe. These processes are like cogs in a wheel, which when run smoothly can make or break your business.
Any kind of credit, be it loans from banks and financial institutions or from an Online fintech lenders, no one lends without making sure of your ability to pay back and pay promptly.
Similarly, when you allow credit to your customer or have some obligations from your suppliers and vendors, it is important to know if they are capable to fulfilling their part of the contract as per the agreed terms.
Volume of Trade Credit
According to research, trade credit is said to account for roughly 11% of the external finance for large firms in India. In the case of SMEs, this is said to be nearly double at around 20%. On the other hand, globally, on an average 19.7% of all investments financed through external sources is via trade credit.
So, it is hard to ignore the role of trade credit and its importance for your business.
Advantages of Trade Credit
Lesser need for financing from banks and financial institutions
Better inventory management
Can make use of discounts offered on prompt payments
Help lower transaction costs
Can react better to demand and supply conditions with trade credit
Importance of Verifying Creditworthiness of Vendors, Suppliers, and Customers
As important is the role of trade credit, so is the verification of vendors, suppliers, and customers. By verifying your vendors, suppliers, and customers, you are saving your business from potential risks.
These risks could be in terms of loss of credibility (when vendors/suppliers delay raw materials, thereby delaying production), risk of financial loss (when your customers do not pay on time and you have to obtain finance for working capital elsewhere, customers not paying at all), etc.
The consequences of these risks could manifest in many ways, thereby making credit verification a very important task that any business owner should undertake before commencing business.
Ways in which creditworthiness can be checked
Asking the concerned party to fill out credit applications
Whenever a customer approaches you for payment on credit, you could ask them to fill out a credit application form which would require them to fill in basic information on their business like the registered address of the company, contact information including details of Key operating personnel, GST registration numbers if any, TAN and PAN numbers, etc.
The application should also ask them to fill in at least 3-4 business references from whom they take trade credit. You can verify creditworthiness of your customers by cross-checking with the references provided there.
If your potential customer struggles to fill in the references, then it may indicate a red flag. Once you have the references in hand, you may want to call/ get in touch with the references and inquire about the payment patterns, creditworthiness, etc.
Make Use of Publicly Available Information about the company
There is a ton of information available in the public domain about company dealings, their customers, financial state, orders bagged, new inventions and processes carried about, their partners, etc. The social media stream is also a great resource these days to know how a company goes about doing their business.
Public Limited companies have to mandatorily file their statement of accounts, audit report, etc. with the Securities and Exchange Board of India (SEBI). You could check the accounts payable and accounts receivable cycles of the company from there documents filed there.
Ratings companies like CRISIL and CARE rate the debt instruments issued by many companies. These provide a good view of how regular a company is in its interest payments, which further goes on to show the creditworthiness.
All this information could be used to evaluate the creditworthiness of a company.
You could consider using the services of Credit Bureaus/Rating Services
These days every credit you avail from a bank/ financial institution and every associated action like repayment, default, closure or settlement of credit accounts are mandatorily reported to the credit bureaus. In addition, the credit bureaus offer many other business information services that could be used to evaluate the creditworthiness of your vendors or customers.
All 4 credit bureaus in India i.e. CIBILTM, Equifax, Experian, and CRIF High Mark go much beyond provide business credit scores and reports.
Some of the services provided by the credit bureaus are:
Business Information Report which helps you determine a company's profitability, financial stability, and payment performance. The BIR provides an in-depth profile of a company, including financial statements, history of business, ownership details, operational information, and details on related firms and special events that occurred in the past involving company management.
Customer acquisition solutions help you review credit histories with greater precision, score and qualify consumers. They can also help you potentially predict their future behavior. That way, you can engage and retain consumers and build your customer base with greater confidence.
Fraud and ID management services deliver more of the insights you need to help quickly assess risk, better avoid fraud and strengthen inefficiencies.
In addition, you could also check SME ratings issued by CRISIL which indicates financial stability and operational efficiency of MSMEs in India. The same could also be checked at CRISIL SME CONNECT which is a journal circulated among banks, financial institutions and SMEs.
So next time do not forget to evaluate the creditworthiness of your vendors and customers before you think of extending credit to them.