Trade credit — the ability to buy now and pay later on supplier terms — is one of the most widely used forms of business finance in Australia. It appears to be free: no interest, no formal application, no security. But trade credit is not free, and for many businesses the implicit cost of extended payment terms is higher than the cost of a business loan. Understanding this distinction can improve both cash management and supplier relationships.
The hidden cost of trade credit: the early payment discount
Many suppliers offer early payment discounts — for example, "2/10 net 30" (a 2% discount if paid within 10 days, otherwise full payment due in 30 days). When a buyer declines the early payment discount and takes the full 30 days, they are effectively paying a financing charge. The annualised cost of the "2/10 net 30" terms is approximately 36.5% per annum — far higher than any bank facility.
The formula: annualised cost = (discount% / (1 - discount%)) × (365 / (net days - discount days)). For 2/10 net 30: (2% / 98%) × (365 / 20) = 0.0204 × 18.25 = 37.2% per annum.
When suppliers charge interest on overdue accounts
Suppliers who charge interest on overdue accounts at 1.5–2% per month are charging 18–24% per annum. For a buyer with access to a business line of credit at 8–10% per annum, paying the supplier's interest is clearly more expensive than drawing on the bank facility and paying the supplier promptly.
The relationship cost
Beyond the explicit financial cost, consistently late payment to suppliers creates relationship risk: the supplier may reduce credit limits, require prepayment, or (in a supply-constrained market) deprioritise the buyer's orders. These non-financial costs can be significant in sectors where supplier relationships drive competitive advantage.
When trade credit is economically rational to use
Trade credit is economically rational when: the implicit cost (foregone discount or interest rate) is lower than alternative financing costs; the buyer has no access to alternative financing; or the supplier explicitly offers interest-free terms without an alternative discount option. In these circumstances, using trade credit as a financing tool is rational and cost-effective.
The strategic view for creditors
From the supplier's perspective, the same analysis applies in reverse. Extended credit terms provided without an interest charge represent a financing cost to the supplier — they are funding their customers' working capital at zero return. Understanding the implicit cost of the credit you extend, and whether your terms reflect the risk you are taking, is fundamental to credit management.
Contact Merion if you are reviewing your credit terms and want advice on structures that balance sales support with credit risk management.