Cash is king -- but credit is the grease that keeps the wheels of business turning smoothly. Credit is crucial to the functioning of almost any business, even if the business doesn't have access to "formal" sources of credit like banks. Here, we try to lay out why credit is crucial, and the many forms it can take.
You might be confident you can generate cash -- say, because you know you can complete a job by a certain date -- but until you have those dollars in hand, you can't spend the cash. Or can you?
If others trust you -- if you have credit with them -- they may let you "spend" this future cash today, in the form of ordering goods and services, taking a cash advance, or receiving a term loan.
In turn, having that "future cash" available frees up real cash for other, immediate needs.
No business can consistently grow without using some form of credit. This may sound like a bold statement, but it's absolutely true. Unless you already have infinite cash, growing a business without credit will eventually bankrupt you. Here's an example that shows why.
Let's say Alice's Aquariums tries to run a business where she never uses credit. She pays cash up front, gets aquariums and goldfish, and sells them. As she grows over time, she reinvests all of her profits in buying inventory with cash.
Eventually, though, a big customer demands a big shipment, and waits 60 days to pay for it. If Alice doesn't have a way to access that "future cash," she could go broke waiting. In effect, she just became a bank, lending to her big customer. Unless she has as much cash as a bank, that's a losing strategy.
Maybe in a perfect world, this will never happen to your small business. But in the real world, even if you avoid dealing with credit, someone will eventually take credit from you (like that slow-paying big customer). Unless you have enough cash to be your own bank, you need credit.
The kind of credit we usually think about is financial credit, as in "credit card" or "line of credit." (See the link for more on types of financial credit, and how and where to get it.) Formal financial credit, such as from banks, is important -- but not the most important source of credit.
The most crucial form of credit for small businesses is trade credit. In a nutshell, trade credit is the waiting period between getting goods or services, and paying for them. See our lesson trade credit for more, but in the meantime, you should know that at any point in time, $2 trillion (that's two million millions) is outstanding in trade credit to small businesses.
Finally, we call another category of credit hidden credit. You probably both give and receive "hidden" credit all the time. For example, an employee who waits two weeks to get paid is extending you credit for those two weeks. Likewise, you're extending 30 days' credit to a landlord by paying him on January 1st for the entire month's rent.
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