Trade credit

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Trade credit is the credit extended by one trader to another for the purchase of goods and services. Trade credit facilitates the purchase of supplies without immediate payment. Trade credit is commonly used by business organisations as a source of short-term financing. It is granted to those customers who have a reasonable amount of financial standing and goodwill. [1]

Contents

There are many forms of trade credit in common use. Various industries use various specialized forms. They all have, in common, the collaboration of businesses to make efficient use of capital to accomplish various business objectives.

Trade credit is the largest use of capital for a majority of business-to-business (B2B) sellers in the United States and is a critical source of capital for a majority of all businesses [2] . For example, Wal-Mart, the largest retailer in the world, has used trade credit as a larger source of capital than bank borrowings; trade credit for Wal-Mart is 8 times the amount of capital invested by shareholders. [3] [4]

Example

The operator of an ice cream stand may sign a franchising agreement, under which the distributor agrees to provide ice cream stock under the terms "Net 60" with a ten percent discount on payment within 30 days, and a 20% discount on payment within 10 days. This means that the operator has 60 days to pay the invoice in full. If sales are good within the first week, the operator may be able to send a cheque for all or part of the invoice, and make an extra 20% on the ice cream sold. However, if sales are slow, leading to a month of low cash flow, then the operator may decide to pay within 30 days, obtaining a 10% discount, or use the money for another 30 days and pay the full invoice amount within 60 days.

Ice cream A frozen dessert

Ice cream is a sweetened frozen food typically eaten as a snack or dessert. It is usually made from dairy products, such as milk and cream, and often combined with fruits or other ingredients and flavors. It is typically sweetened with sugar or sugar substitutes. Typically, flavourings and colourings are added in addition to stabilizers. The mixture is stirred to incorporate air spaces and cooled below the freezing point of water to prevent detectable ice crystals from forming. The result is a smooth, semi-solid foam that is solid at very low temperatures. It becomes more malleable as its temperature increases.

Franchising practice of the right to use a firms business model and brand for a prescribed period of time

Franchising is based on a marketing concept which can be adopted by an organization as a strategy for business expansion. Where implemented, a franchiser licenses its know-how, procedures, intellectual property, use of its business model, brand, and rights to sell its branded products and services to a franchisee. In return the franchisee pays certain fees and agrees to comply with certain obligations, typically set out in a Franchise Agreement.

Distributor device in the ignition system of an internal combustion engine

A distributor is an enclosed rotating shaft used in spark-ignition internal combustion engines that have mechanically-timed ignition. The distributor's main function is to route secondary, or high voltage, current from the ignition coil to the spark plugs in the correct firing order, and for the correct amount of time. Except in magneto systems, the distributor also houses a mechanical or inductive breaker switch to open and close the ignition coil's primary circuit.

The ice cream distributor can do the same thing. Receiving trade credit from milk and sugar suppliers on terms of Net 30, 2% discount if paid within ten days, means they are apparently taking a loss or disadvantageous position in this web of trade credit balances. Why would they do this? First, they have a substantial markup on the ingredients and other costs of production of the ice cream they sell to the operator. There are many reasons and ways to manage trade credit terms for the benefit of a business. The ice cream distributor may be well-capitalized either from the owners' investment or from accumulated profits, and may be looking to expand his markets. They may be aggressive in attempting to locate new customers or to help them get established. It is not in their best interests for customers to go out of business from cash flow instabilities, so their financial terms aim to accomplish two things:

Milk white liquid produced by the mammary glands of mammals

Milk is a nutrient-rich, white liquid food produced by the mammary glands of mammals. It is the primary source of nutrition for infant mammals before they are able to digest other types of food. Early-lactation milk contains colostrum, which carries the mother's antibodies to its young and can reduce the risk of many diseases. It contains many other nutrients including protein and lactose. Interspecies consumption of milk is not uncommon, particularly among humans, many of whom consume the milk of other mammals.

Sugar generic name for sweet-tasting, soluble carbohydrates

Sugar is the generic name for sweet-tasting, soluble carbohydrates, many of which are used in food. The various types of sugar are derived from different sources. Simple sugars are called monosaccharides and include glucose, fructose, and galactose. "Table sugar" or "granulated sugar" refers to sucrose, a disaccharide of glucose and fructose. In the body, sucrose is hydrolysed into fructose and glucose.

Markup is the ratio between the cost of a good or service and its selling price. It is expressed as a percentage over the cost. A markup is added into the total cost incurred by the producer of a good or service in order to cover the costs of doing business and create a profit. The total cost reflects the total amount of both fixed and variable expenses to produce and distribute a product. Markup can be expressed as a fixed amount or as a percentage of the total cost or selling price. Retail markup is commonly calculated as the difference between wholesale price and retail price, as a percentage of wholesale. Other methods are also used.

  1. Allow startup ice cream parlors the ability to mismanage their investment in inventory for a while, while learning their markets, without having a dramatic negative balance in their bank account which could put them out of business. This is in effect, a short term business loan made to help expand the distributor's market and customer base.
  2. By tracking who pays, and when, the distributor can see potential problems developing and take steps to reduce or increase the allowed amount of trade credit he extends to prospering or exposure to losses from customers going bankrupt who would never pay for the ice cream delivered.

Alternatives

One alternative to straightforward trade credit is when a supplier offers to give product on consignment to a trader e.g. a gift shop. The terms of the arrangement mean that the original supplier retains ownership of the goods until the shop sells them.

Consignment is the act of consigning, the act of giving over to another person or agent's charge, custody or care any material or goods but retaining legal ownership until the material or goods are sold. That may be done for the purpose of shipping the goods, transferring the goods to auction or intending the goods to be placed on sale in a store.

See also

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Factoring (finance) financial transaction and a type of debtor finance in which a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount

Factoring is a financial transaction and a type of debtor finance in which a business sells its accounts receivable to a third party at a discount. A business will sometimes factor its receivable assets to meet its present and immediate cash needs. Forfaiting is a factoring arrangement used in international trade finance by exporters who wish to sell their receivables to a forfaiter. Factoring is commonly referred to as accounts receivable factoring, invoice factoring, and sometimes accounts receivable financing. Accounts receivable financing is a term more accurately used to describe a form of asset based lending against accounts receivable. The Commercial Finance Association is the leading trade association of the asset-based lending and factoring industries.

Accounts payable money owed by a business to its suppliers

Accounts payable (AP) is money owed by a business to its suppliers shown as a liability on a company's balance sheet. It is distinct from notes payable liabilities, which are debts created by formal legal instrument documents.

Accounts receivable legally enforceable claim for payment to a business by its customer/ clients for goods supplied and/or services rendered in execution of the customer’s order

Accounts receivable is a legally enforceable claim for payment held by a business for goods supplied and/or services rendered that customers/clients have ordered but not paid for. These are generally in the form of invoices raised by a business and delivered to the customer for payment within an agreed time frame. Accounts receivable is shown in a balance sheet as an asset. It is one of a series of accounting transactions dealing with the billing of a customer for goods and services that the customer has ordered. These may be distinguished from notes receivable, which are debts created through formal legal instruments called promissory notes.

An invoice, bill or tab is a commercial document issued by a seller to a buyer, relating to a sale transaction and indicating the products, quantities, and agreed prices for products or services the seller had provided the buyer.

net 10, net 15, net 30 and net 60 are forms of trade credit which specify that the net amount is expected to be paid in full by the buyer within 10, 15, 30 or 60 days of the date when the goods are dispatched or the service is completed. Net 30 or net 60 terms are often coupled with a credit for early payment.

Receipt written acknowledgment that a person has received money or property in payment

A receipt, is a document acknowledging that a person has received money or property in payment following a sale or other transfer of goods or provision of a service. All receipts must have the date of purchase on them. If the recipient of the payment is legally required to collect sales tax or VAT from the customer, the amount would be added to the receipt and the collection would be deemed to have been on behalf of the relevant tax authority. In many countries, a retailer is required to include the sales tax or VAT in the displayed price of goods sold, from which the tax amount would be calculated at point of sale and remitted to the tax authorities in due course. Similarly, amounts may be deducted from amounts payable, as in the case of wage withholding taxes. On the other hand, tips or other gratuities given by a customer, for example in a restaurant, would not form part of the payment amount or appear on the receipt.

Working capital is a financial metric which represents operating liquidity available to a business, organisation or other entity, including governmental entities. Along with fixed assets such as plant and equipment, working capital is considered a part of operating capital. Gross working capital is equal to current assets. Working capital is calculated as current assets minus current liabilities. If current assets are less than current liabilities, an entity has a working capital deficiency, also called a working capital deficit.

Voucher receipt or bond with a certain value

A voucher is a bond of the redeemable transaction type which is worth a certain monetary value and which may be spent only for specific reasons or on specific goods. Examples include housing, travel, and food vouchers. The term voucher is also a synonym for receipt and is often used to refer to receipts used as evidence of, for example, the declaration that a service has been performed or that an expenditure has been made. Voucher is a tourist guide for using services with a guarantee of payment by the agency.

Debtor finance is an umbrella term used to describe a process to fund a business using its accounts receivable ledger as collateral. Generally, companies that have low working capital reserves can get into cash flow problems because invoices are paid on net 30 terms. Debtor finance solutions fund slow-paying invoices, which improves the cash flow of the company and puts it in a better position to pay operating expenses.

Global supply-chain finance refers to the set of solutions available for financing specific goods and/or products as they move from origin to destination along the supply chain. It is related to a quickly growing use of a battery of technologies and financial business practices that allow for discounting of Accounts Receivable and financing of companies' confirmed Accounts Payable.

In bookkeeping, accounting, and finance, Net sales are operating revenues earned by a company for selling its products or rendering its services. Also referred to as revenue, they are reported directly on the income statement as Sales or Net sales.

Dynamic Discounting describes a collection of methods in which payment terms can be established between a buyer and supplier to accelerate payment for goods or services in return for a reduced price or discount. Dynamic Discounting methods are used for business-to-business transactions when contractual or pre-established early payment terms may not exist or the payment date does not conform to agreed upon discount terms. Dynamic Discounting includes the ability to agree upon terms that vary the discount according to the date of early payment. The earlier the payment, the greater the discount. In addition, it includes an ability for either buyer or supplier to propose an early payment date and discount for a one-time payment using electronic mail or specialized software. Through the use of dynamic discounting methods, buying organizations can increase the number and size of early payment discounts they receive and suppliers can get paid sooner at a lower cost of capital than alternative options. A range of concepts is available to implement dynamic discounting into supply chain finance (SCF): dynamic discounting can be seen as a comparatively simple form, whereby the supplier grants a cash discount for early payment of its invoices – the amount of the reduction and the time of payment are quickly and freely negotiable.

Special journals

Special Journals are designed to facilitate the process of journalizing and posting transactions. They are used for the most frequent transactions in a business. For example, in merchandising businesses, companies acquire merchandise from vendors, and then in turn sell the merchandise to individuals or other businesses. Sales and purchases are the most common transactions for the merchandising businesses. A business such as a retail store will record the following transactions many times a day for sales on account and cash sales.

Unlike traditional factoring, where a supplier wants to finance its receivables, reverse factoring is a financing solution initiated by the ordering party in order to help its suppliers to finance its receivables more easily and at a lower interest rate than what would normally be offered. In 2011, the reverse factoring market was still very small, accounting for less than 3% of the factoring market.

C2FO

C2FO is a financial technology company and the creator of the first market for working capital. C2FO operates the C2FO working capital market.

Electronic invoicing is a form of electronic billing. E-invoicing methods are used by trading partners, such as customers and their suppliers, to present and monitor transactional documents between one another and ensure the terms of their trading agreements are being met. These documents include invoices, purchase orders, debit notes, credit notes, payment terms and instructions, and remittance slips.

Credit control is the system used by a business to make sure that it gives credit only to customers who are able to pay, and that customers pay on time. Credit control is part of the Financial controls that are employed by businesses particularly in manufacturing to ensure that once sales are made they are realised as cash or liquid resources.

The actual price paid to the manufacturer or distributor by the end-customer retailer, which is known as the invoice price. However, in many industries, the "invoice cost" actually varies from the "net purchase cost," or the actual price of a product. The invoice cost of a product is the price that the merchant pays for the product before marking it up to sell. The invoice cost is sometimes used in industries such as automobile sales to entice customers to buy.

A business loan is a loan specifically intended for business purposes. As with all loans, it involves the creation of a debt, which will be repaid with added interest. There are a number of different types of business loans, including bank loans, mezzanine financing, asset-based financing, invoice financing, microloans, business cash advances and cash flow loans.

References

  1. "Trade credit". ACCA.
  2. "Trade Credit". Investopedia.
  3. (Trade credit is the second largest source of capital for Wal-Mart; retained earnings is the largest.)[ verification needed ]
  4. Justin Murfin, Ken Njoroge (March 2014). "The Implicit Costs of Trade Credit Borrowing by Large Firms" (PDF). pdfs.semanticscholar.org.