Trade Credit

The arrangement between the businesses in order to purchase services or goods on accounts without rendering on the spot cash payments is referred to as trade credit. An agreement will be provides to the customer by the supplier to bill the customers later. The supplier will also give a fixed time period with in which the customer should pay back the money. This is considered to be an effective constituent of the capitalization in every operating business since it lowers the capital investment that is required for the effective operation of the business. But one thing that should be kept in mind is that the trade credit has to be managed properly, if not it may turn to be dangerous. Wal-Mart can be taken as a good example in this case. The trade credit has been used by Wal-Mart who is the largest retailer of the world as a big source of capital than other bank borrowing. The Wal-Mart’s trade credit is almost eight times the amount of the capital which is invested by other shareholders.

Trade credit vs bank loans:

Trade credit is the main source of the alternative data for the small business loans and for the personal loans for various borrowers particularly in the developing country. In general use, there are various forms of trade credit that are used. One thing that is common among various industries that uses the trade credit is the motif of collaborating the businesses in order to make effective use of the capital in order to achieve the objectives of the businesses.

Example of the trade credit:

The example of the trade credit is a person who operates an ice cream stand is taken to understand this concept. The distributor of the ice cream agrees to provide the ice cream in the condition of “Net 60” with conditions on discount. The conditions are that there will be a ten percent discount in the ice cream if the payment is done within thirty days. Again the discount in the payment will be 20% if the payment is made within ten days and again the operator of the ice cream stand will have sixty days to make the full payment of the invoice. Under these conditions the ice cream operator will be encouraged to make a purchase from the distributor. At the same time the ice cream operator will also have enough time to sell the ice-cream and make the payment. Again, the ice cream distributor can do this same to the sugar suppliers and the milk suppliers.

Questions:

• What is trade credit?
• What is the advantage of trade credit?