Running a business means managing cash flow wisely. Instead of leaving money idle while waiting to pay invoices, why not put it to work for you?

In today’s KOFFi break, We will discuss how you can optimise your trade credit period by parking your idle funds in debt funds. By the end of this blog, you’ll understand how you can earn returns from payables funds for trade credit.

Let’s dive in!

Trade Credit

Trade credit is an invoice payment term where a business can purchase goods or services from a supplier without making an immediate cash payment. 

It allows the business to “buy now, pay later” by giving flexible payment options to pay suppliers within a set period, typically 30-90 days. 

This 30 to 90-day period is called the trade credit period. It can be advantageous for both the buyer and seller, allowing the buyer to have more time for payment for improved cash flow and the seller to generate sales.

Trade credit is a common form of invoice payable terms, with 80-90% of global trade relying on this type of trade finance. 

How Does Trade Credit Function? 

1. Purchase Agreement: The business (buyer) places an order with the supplier (seller) for goods and services. 
2. Invoice Issuance: The supplier delivers the goods/services and issues an invoice detailing the amount due and the payment terms for the business.
3. Credit Period: The business (buyer) gets a specific period to make the payment, which can range from 30 to 90 days or more, depending on the agreement. 
4. Payment: The business (buyer) pays the invoice within the credit period and completes the transaction. 

The 30-day credit period is the most common credit period term. Whereas 60 and 90-day credit periods are often used in industries where the sales cycle is longer.

Debt Funds

Debt funds are the type of funds that only invest in fixed-income debt securities like bonds, treasury bills, commercial papers, and money market instruments. 

These funds are considered lower risk compared to equity funds, as their major assets are allocated into high-quality fixed-income instruments.

Debt funds offer relatively stable capital appreciation, with high liquidity, and a low-cost structure compared to other fund parking options.

They are suitable for businesses for savings and fund parking purposes as they have very low risk due to their asset allocation strategy. 

How Debt Funds Can Help Businesses Optimise The Trade Credit Periods?

This strategy is more beneficial for businesses with better cash flow, which prefer to hold onto their funds until the last possible day to pay their invoices. 

However, the funds which are meant for suppliers usually just sit in the bank accounts, earning nothing, during this period. 

Instead of letting that money sit idle, businesses can park it in debt funds and earn some passive income. 

Debt funds come with the benefits of stable returns, high liquidity, low risk, and flexibility making it an idle option for short-term fund parking. 

Let’s Understand How Much Returns a Business Can Make by Optimising its Trade Credit With Debt Funds: 

For example, A business purchases goods worth ₹10,00,000/- with a 60-day credit period. Instead of keeping that money in their current account, they parked this supplier payable money in  a short-term debt fund for 55 days:

Amount = ₹10,00,000/-

Period = 55 Days

Average Return = 1.1% for 55 days (7% annually)

Total Returns = ₹11,000/- 

Such a simple strategy can help businesses earn additional returns on their parked fund.

Let’s Try To Understand This Strategy Step-By-Step:

Step 1:

Analyze your trade credit and cash flow: First, you need to review your invoices to know about your trade credit periods to understand the duration and amount of the supplier’s money. 

Second, you need to analyze your business cash flows to determine how much you can put into debt funds without affecting your operations.

Step 2:

Select  the  appropriate  debt fund: You will find numerous types of debt funds,  each of them has a different  objective  and goal to provide  higher returns  in (the short term, mid-term, and long term) 

You need to choose a debt fund that matches your credit period.

Besides duration you also need to consider funds return, liquidity, credit rating, etc you can learn more here.

Step 3:

Park and redeem funds: Park the idle funds in the selected debt fund at the beginning of the trade credit period. 

Set the auto redemption before 2 days of the payment due to ensure liquidity. 

Selecting the correct debt fund is crucial in this strategy. Debt funds are of various types and objectives. 

Let’s Understand Which Type Of Debt Fund Is Ideal For Your Business Operation 

Every business is unique, and So is the need for business finance. Trade credit  financing  is mostly used in the manufacturing and retail industries,  so let’s  take these two industries as an example : 

1. Manufacturing: – Manufacturing businesses typically have longer trade credit periods ( 60-90 days) and larger invoice amounts due to longer sales cycles. They can benefit from ultra-short-term duration funds as these funds invest only in debt securities that have a very low maturity period ( less than a month). Thus these funds will be able to provide higher returns for (60 – 90 days) duration. 
2. Services:- Services businesses usually deal with shorter trade credit periods (30 days) due to frequent transactions. They can benefit from overnight funds as these funds invest only in debt securities that have a maturity period of one day.  Thus this fund will be able to provide higher returns for ( 30 days) duration.  

These funds are an ideal option for the duration specific to these two industries. It is essential to find the perfect debt fund tailored to the nature of your business.

Risk And Considerations 

While debt funds are low-risk instruments, they are not entirely risk-free. Here are some potential risks you should  be aware of and keep in mind while selecting  a debt fund :

1. Interest rate risk: The value of the debt funds can fluctuate with the change in interest rates.
2. Credit risk: As debt funds invest in the debt securities there’s a risk of default by the securities in which the debt fund invests.

To mitigate these risks you need to check all these 5 things for selecting a debt fund. This will help you to choose more good quality debt funds for your business finances. 

Final Thought

Optimising trade credit with debt funds is a smart strategy for making your idle funds work harder for you.

By leveraging the trade credit period and customising the approach based on your business operations, you can earn better returns and improve your financial health. Start exploring debt funds today and see how this simple move can benefit your business.

Did you find this information valuable? Share this blog with someone who is actively using trade credit. Help them make informed financial decisions just as you do!