Accounts payable financing, also known as trade credit or vendor financing, is a new form of credit where businesses borrow money from a vendor in order to purchase said vendor’s goods or services.
Just like invoice factoring, qualifying for an accounts payable financing is based on the buyer’s creditworthiness. Most businesses don’t have to put up any collateral, but it’s important for potential lenders to review your credit history to see if you can qualify for a loan.
For businesses in need of additional working capital, accounts payable financing is a great solution. With this type of financing, you don’t have to tap into your business assets or resources to purchase additional inventory. Other benefits include:
- Building and establishing a great relationship with various vendors/suppliers.
- Availing special discounts, bulk discounts, or special promos in the future. (Vendors often choose businesses with a great payment history when rationing their products.)
How Does Accounts Payable Financing Work?
With accounts payable financing, business owners typically provide credit to finance a percentage of the total price of the goods and services they’re purchasing.
Once the business and the vendor come to an agreement, the business is required to make the initial payment. The remaining balance, along with accumulated interest, is paid off throughout the duration of the agreement. Interest rates may vary from 5% to 10%, although it can sometimes jump higher.
Here’s a concrete example, assume Business A wants to purchase $100,000 worth of inventory from Vendor Z, but Business A doesn’t have enough working capital to finance additional inventory purchases. Business A only has $30,000 in cash and they’re looking to borrow the rest. Fortunately, Vendor Z is willing to negotiate a vendor financing agreement with Business A for the remaining $70,000.
Vendor Z will charge a 10% interest on the loan, and Business A has to pay the debt within two years. Vendor Z also puts up the purchased inventory as collateral for the loan to protect itself against defaults.
Why Do Businesses Prefer Accounts Payable Financing?
There are two main reasons businesses opt for accounts payable financing:
Substantial Amounts of Cash is Not Required
Business owners who are short on working capital will benefit from an accounts payable financing plan because it doesn’t require a substantial amount of working capital to fund the purchase of additional inventory. In accounts payable financing, business owners only have to pay a small percentage of the total cost of goods – usually around 10% to 20% – and the remaining amount can be raised after acquiring the added inventory.
Pay Debts with Business Profits
With accounts payable financing, business owners do not need to pay the total amount of purchases upfront. Instead, they can make regular payments to the service loan using the income generated by their business. This makes it easier for business owners to repay the debt incurred from accounts payable financing compared to other types of loans.
If you want to know more about accounts payable financing, The experts at SMB Compass can answer all your questions and steer you in the right direction.
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