A Snapshot View of the Small Business Trade Credit Market

Navigator Edition: April 2012
By: Balaji Viswanathan

Trade credit, the extension of credit from seller to buyer, is an important source of financing for small businesses.  Trade credit can inject critical short-term cash flow into small businesses and can significantly improve working capital.  According to the Small Business Administration, approximately sixty percent of small businesses are estimated to use trade credit, with a third of these firms relying exclusively on trade credit for financing purchases.  The remainder use both bank financing (e.g., line of credit, term loan, revolving line, general purpose credit card) and trade credit.

Small businesses that use trade credit are typically a little bit larger since larger firms are in better position to negotiate terms with their suppliers.  In addition, the use of trade credit is generally higher among firms with higher liquidity and lower among firms that have better credit quality.  Lower credit quality increases the cost of bank-originated credit financing and makes trade credit financing more attractive on a relative basis.

Although smaller than the small business card market, the trade credit financing market is large and relatively profitable.  Based on publicly available data and good faith assumptions, we estimate that the small business trade credit market accounts for about $400 billion in spend and about $130 billion in average outstanding balance as shown in Figure 1.

Figure 1: U.S.  Small Business Trade Credit Market Sizing Estimate


Source: 12008 Visa Commercial Consumption Report.  2012 NFIB Report on Small Business Credit.  First Annapolis Consulting assumption.

Based on our estimate of the trade credit market P&L, the pre-tax net income is about four percent of the average outstanding balance for third-party providers who manage and fund trade credit programs on behalf of retailers and suppliers to small businesses.  (Typically, a retailer or supplier who has an in-house trade credit program does not receive an acceptance fee and their operating costs would be higher with less scale.  Consequently, in-house programs are typically viewed as a cost center and are sought to be managed in the 1.5% to 2.0% cost of credit range.)

Trade credit is a vital source of financing for small businesses.  Offering trade credit solutions as part of their product offerings could be a profitable path for financial institutions and other credit grantors to expand their small business customer base and build customer loyalty.

For more information, please contact Balaji Viswanathan, Consultant specializing in Commercial Payments,balaji.viswanathan@firstannapolis.com

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