Updated: Jan 26, 2022
Oftentimes, when asked what types of credit they already have, business owners will stammer, or say they aren't sure, or will say they don’t have any credit, or that they have some trade lines or a few basic credit cards.
In reality, they may be further along in the credit-building process than they even know. Few realize that just about everything their business pays for, in one way or another, is going to be considered a debt — whether it is paid for ahead of time, at the point of sale, on net terms, or over a period of days, weeks, months, or years.
Below is a basic breakdown to help you better understand the different types of credit:
VENDOR credit is defined as accounts with suppliers who provide products or services to any industry but not to any specific industry, such as office supplies, signs, computers, fuel, paper, software, forms, tools, etc. These are the things that most business owners will need in day-to-day operations.
TRADE credit is generally Net, Open, Lease, or Set term accounts, established to purchase products or services specific to your industry, such as selling tires to a tire store, food to a restaurant, pipes to a plumber, or flowers to a florist. If the florist buys tires, for instance, it would be classified as Vendor credit instead of Trade credit.
RETAIL credit generally refers to companies who sell to private consumers as well as commercial customers and offer a variety of account types and repayment terms. A few examples would include: Home Depot, Office Depot, Sears, or Dell. How these transactions get reported to the bureaus will depend on multiple factors, such as whether they are based solely on the business credit or are personally guaranteed, and whether they are Net or Revolving accounts.
FINANCING generally describes accounts created for the purpose of making a monthly payment for a high dollar product or service, such as leasing a photocopier or vehicle, or paying on an expensive contracted service.
FUNDING relates to “projects” rather than “products”. For instance, you may be looking for funding to build a new warehouse, expand to global markets, or start a new division of an existing business. Funding generally involves contractual agreements setting a specific date or percentage of proceeds to finalize the settlement.
WORKING CAPITAL falls under the loan category below, but we are putting it in here because funds are made available by a lender on Set terms. These terms will vary depending on what portion of the capital is available or in use, and what specific repayment has been established. A good example of a working capital would be a loan made to the business through their merchant account, and the provider will hold 10% of all new transactions processed through the account until the debt is repaid. It can be paid off in regular payments or in advance, but it must be repaid in full by a set date.
FACTORING is somewhat related to working capital in that the lender allows you to “factor” your open invoices against a debt. The lender lends you funds against the invoices and therefore owns the proceeds of those invoices when they are paid. If you have a contract that will pay you $10,000 per month, you can factor those invoices to get your funds for the contract now. When the invoices are paid, the payment will go directly to the lender to repay your debt.
LINE OF CREDIT is a note generally issued by a bank or other funding source allowing access to funds up to a specified amount. The business only uses what funds they need from time to time, and only makes repayment and pays interest on the percentage of funds they have in use at any given time. Example: a landscaper needs more plants and supplies in the spring and less in the winter. If the bank allows a line of credit for $100,000, the landscaper can use $10,000 now, paying only the interest and payment on that amount. But if, in the spring, the landscaper needs to use $50,000 to restock with new plants, the funds are already available without having to re-apply for another loan. At that point, he would start paying on the balance he has out at that time.
LOAN refers specifically to borrowed funds paid out in full and repaid in the specific terms outlined in the agreement, such as a real estate loan, bridge loan, or construction loan. These are generally collateral-based agreements requiring complex contracts and higher guarantees, but generally will have lower interest rates because they are based upon a company’s proven history or the demand in the market. A good example would be a local motorcycle shop who has shown increasing growth in their sales and bank balances over time. When they want a loan to add on to their existing building, the bank will be able to see their history and know it is a good investment with low risk.
We like to refer to the above as a Credit Ladder because each rung will usually lead to the next. No matter what type of credit you are working for, we can help you build a solid foundation to make your climb to the top easier and more rewarding when you get there.
LESSON: And here a few more!
COD ~ Cash-on-delivery or paid at point of sale PREPAID ~ Paid before services are rendered ACH ~ Autodrafts from bank account or credit card NET ~ To be paid within specific days allowed SET ~ Paid when collected from third party LEASE ~ Paid on specific day of each month OPEN ~ Special terms between both parties REVOLVING ~ Carrying a balance over a period of time