Vendor financing is an arrangement by which the vendor — the company or organisation providing a product or service — finances the provision of those things for you. This means that you don’t make a full payment up front and that you can receive and use the goods before you take care of any balance you owe. The terms of vendor finance agreements vary widely by situation and industry. While financing purchases for your business does increase your debt, it can be a viable strategy when handled the right way.
Types of Vendor Financing Arrangements
Within legal and banking requirements, vendors can make all manner of arrangements with their business partners. Commonly, vendors that provide on-credit purchasing or in-house financing do so by creating terms for payment. They might require that the customer make payment within 15, 30 or 45 days of receipt on an invoice, for example. Another option is a revolving line of credit that works much like a credit card: Interest is charged, and as long as a regular payment is made, the customer can order up to the ceiling on the credit account.
Some vendors create term structures that reward good payment habits. An example of this can be seen when vendors provide interest-free credit options as long as you pay the balance in full within a set time limit. Another example might be a credit ceiling that is raised as you continue to pay on time or manage your balances appropriately.
Why Do Vendors Offer Financing?
It might seem odd that vendors don’t want your money right away, but the truth is that vendors need your patronage any way they can get it. In the modern market, where cash flow is a major challenge for many organisations, vendors know they risk losing viable business if they don’t offer any type of credit option. In return for making goods more available to businesses in this manner, vendors might charge a small finance fee or interest. In short, vendors offer financing because it’s good for their bottom lines.
When Vendor Financing Makes Good Business Sense
Modern financial experts often caution against the use of credit, and debt can be a negative factor for business value and stability. In most cases, though, vendor financing is considered a standard cost for doing business, and it could even be required to grow your company.
Consider a hotel owner who has added a wing onto his property. He has five new rooms to rent, but he can’t rent them until he has placed furnishings inside. Having spent his reserves on building the wing itself, he has several choices: dip into operating cash to buy furnishings, pay for furnishings out of personal funds, use a credit card or equity loan to cover the cost, or work with a vendor that supplies furnishings on credit. Often, the choice that leaves the hotel owner with cash flow to run his business while also minimizing the cost of credit is vendor financing.
Vendor financing is a good option when:
- It’s the least costly form of credit open to you
- You need the supplies or services to create new business or land a new account
- You have a plan to pay off the balance within the terms stated
- You aren’t relying solely on vendor credit to run your business every day
When Vendor Financing Could Be a Cover for a Struggling Company
When pushed to the extreme, vendor financing can be bad for your business. If you’re so desperate for goods that you agree to unsavory terms that make those goods too expensive, you risk mitigating any profit you might have made. Businesses that can’t make regular or timely payments on vendor credit can end up in a cycle that keeps them forever mired in debt, and companies that come to rely on vendor credit for every purchase might be hiding viability issues under their debt. When it comes down to it, if you simply can’t afford to operate your business, vendor financing isn’t a forever answer.
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