Trade Credit in India

In the changing world of business, managing cash flow efficiently becomes one of the primary challenges that a company can face.  From small companies to large ones, businesses are required to maintain equilibrium between tasks like purchasing materials, maintaining enough stocks, and maintaining liquidity for daily operations. Trade credit has been instrumental in achieving this goal. Trade credit serves as a financial tool for businesses to maintain a continuous flow of goods and services without the need for immediate payment.

What is Trade Credit?

Trade credit is a simple yet powerful concept. It’s when a business buys goods or services from a supplier and agrees to pay for them later—usually within 30 to 90 days after receiving the items. Instead of paying upfront, the buyer gets some breathing space to make the payment. This helps businesses maintain smooth operations without draining their cash reserves.

For example, imagine a clothing store buys fabric from a supplier. Instead of paying immediately, the store has 60 days to pay. In the meantime, it can sell the fabric, earn money, and then pay the supplier. Both sides win.

Types of Trade Credit

Trade credit isn’t just one-size-fits-all. There are different types based on how the deal is structured:

Open Account: This is the simplest form. The buyer gets the goods and promises to pay within a certain period (like 30, 60, or 90 days). There are no written contracts, just trust.

Promissory Note: Here, the buyer signs a document promising to pay by a certain date. It’s legally binding.

Bill of Exchange: This is a formal written order where the buyer agrees to pay the supplier at a later date, often with a third party involved.

Trade Credit Insurance: In this case, suppliers take out insurance to protect themselves if the buyer doesn’t pay. It’s like a safety net.

How Does Trade Credit Work in India?

In India, trade credit is a lifeline for small and medium-sized businesses (SMBs). Here’s how it works:

Business Relationships: Trust is everything. Suppliers and buyers often rely on their history of payments and reputation to decide whether to extend credit. In India, businesses heavily depend on word-of-mouth and personal connections.

Payment Terms: Terms are usually negotiated. While 30 to 90 days is standard, some suppliers may offer more time, especially if the buyer has a solid credit history.

Credit Risk: There’s always a risk. Suppliers worry about getting paid late—or not at all. Buyers risk penalties for late payments. To avoid trouble, suppliers in India often check the buyer’s creditworthiness before offering credit.

Legal Framework: Trade credit in India is governed by laws like the Indian Contract Act and the Sale of Goods Act. These ensure contracts are valid and binding, and suppliers can take legal action if payments are missed. But it’s a slow and costly process.

Why is Trade Credit a Big Deal in India?

India’s business world is diverse, ranging from manufacturing to retail, and many companies, especially small and medium-sized ones, rely on trade credit. Here’s why it’s crucial:

Cash Flow Management: Trade credit helps businesses maintain a steady flow of goods without having to part with cash immediately. It’s perfect for businesses with unpredictable sales cycles, like retailers or manufacturers in India.

Flexibility: With trade credit, businesses don’t have to pay upfront. They get the goods or services now, and can sell them or use them to make money, paying the supplier later. It’s a big win for businesses, especially in a country like India, where cash flow can be a struggle.

No Interest (If Paid on Time): As long as businesses pay on time, there’s usually no interest. This is much cheaper than other financing options like loans, which often come with high interest rates.

The Risks of Trade Credit

Even though trade credit can be super useful, there are some downsides:

Credit Risk: The biggest issue is that suppliers risk not getting paid. If the buyer defaults, the supplier’s cash flow gets hit hard.

Late Payments: In India, late payments are a common problem. Many businesses delay payments to suppliers, especially in sectors like construction or retail. This creates a chain reaction, hurting everyone involved.

Over-Reliance on Suppliers: If a business becomes too dependent on trade credit, it can be in trouble if suppliers tighten the credit terms or stop offering trade credit altogether.

The Role of Trade Credit in India’s Economy

Trade credit is vital to the Indian economy, especially for SMEs, which make up a large portion of the business landscape. For small businesses, trade credit acts as a bridge, allowing them to produce and sell goods without waiting to gather enough cash to buy raw materials.

The Indian government has made efforts to improve the ease of doing business, and this, combined with the rise of digital payments, has made it easier for businesses to access and manage trade credit.

Questions to Understand your ability

Q1.) What’s the main reason businesses love trade credit?

a) It lets businesses grab goods without paying a single rupee upfront.

b) It locks businesses into sky-high interest rates.

c) It forces businesses to pay suppliers right away.

d) It throws in discounts on all products purchased.

Q2.) Which of the following is NOT a type of trade credit mentioned in the article?

a) Open Account

b) Promissory Note

c) Loan Credit

d) Bill of Exchange

Q3.) When suppliers in India hand out trade credit, what’s their main concern?

a) How big the buyer’s company is

b) Whether the buyer pays on time, based on past history

c) The buyer’s slice of the market pie

d) The buyer’s logo design

Q4.) What’s the biggest risk for suppliers offering trade credit?

a) Losing customers

b) The buyer ghosting on payments

c) The buyer asking for refunds

d) Interest rates soaring

Q5.) Why do small and medium-sized businesses (SMBs) in India swear by trade credit?

a) It lets them grab raw materials now and pay later—no upfront costs.

b) It floods them with government cash.

c) It guarantees them access to loans with insane interest.

d) It promises profit on every sale.

Conclusion

For Indian enterprises, trade credit is a game-changing weapon. Businesses can manage cash flow, maintain smooth operations, and expand by enabling them to make purchases now and pay later. Risks like defaults and late payments may exist, but with careful preparation and solid connections, trade credit can provide companies with the financial flexibility they want to thrive.