Trade credit is the

loan In finance, a loan is the tender of money by one party to another with an agreement to pay it back. The recipient, or borrower, incurs a debt and is usually required to pay interest for the use of the money. The document evidencing the deb ...

extended by one trader to another when the

goods In economics, goods are anything that is good, usually in the sense that it provides welfare or utility to someone. Alan V. Deardorff, 2006. ''Terms Of Trade: Glossary of International Economics'', World Scientific. Online version: Deardorffs ...

and services are bought on

credit Credit (from Latin verb ''credit'', meaning "one believes") is the trust which allows one party to provide money or resources to another party wherein the second party does not reimburse the first party immediately (thereby generating a debt) ...

. Trade credit facilitates the purchase of supplies without immediate payment. Trade credit is commonly used by business organizations as a source of short-term financing. It is granted to those customers who have a reasonable amount of financial standing and goodwill. (Kuveya, 2020) 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 Business-to-business (B2B or, in some countries, BtoB) refers to trade and commercial activity where a business sees other businesses as its customer base. This typically occurs when: * A business sources materials for its production process for ...

(B2B) sellers in the United States and is a critical source of capital for a majority of all businesses. For example,

Wal-Mart Walmart Inc. (; formerly Wal-Mart Stores, Inc.) is an American multinational retail corporation that operates a chain of hypermarkets (also called supercenters), discount department stores, and grocery stores in the United States and 23 other ...

, 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.

Example

The operator of an

ice cream Ice cream is a frozen dessert typically made from milk or cream that has been flavoured with a sweetener, either sugar or an alternative, and a spice, such as Chocolate, cocoa or vanilla, or with fruit, such as strawberries or peaches. Food ...

stand may sign a franchising agreement, under which the

distributor A distributor is an electric and mechanical device used in the ignition system of older spark-ignition engines. The distributor's main function is to route electricity from the ignition coil to each spark plug at the correct time. Design ...

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. If the ice cream distributor for its part were to receive trade credit from

milk Milk is a white liquid food produced by the mammary glands of lactating mammals. It is the primary source of nutrition for young mammals (including breastfeeding, breastfed human infants) before they are able to digestion, digest solid food. ...

and

sugar Sugar is the generic name for sweet-tasting, soluble carbohydrates, many of which are used in food. Simple sugars, also called monosaccharides, include glucose Glucose is a sugar with the Chemical formula#Molecular formula, molecul ...

suppliers on terms of net 30 and 2% discount if paid within ten days, it would appear it were taking a loss or disadvantageous position in this web of trade credit balances. The ice cream distributor may be willing to do so if it has a substantial markup on the ingredients and other costs of production of the ice cream it sells to the operator, but there exists more than one reason to manage trade credit terms for the benefit of a business, and more than one way to do so. 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: # Allow startup ice cream parlors the ability to mismanage their investment in

inventory Inventory (British English) or stock (American English) is a quantity of the goods and materials that a business holds for the ultimate goal of resale, production or utilisation. Inventory management is a discipline primarily about specifying ...

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

made to help expand the distributor's market and customer base. # 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 Bankruptcy is a legal process through which people or other entities who cannot repay debts to creditors may seek relief from some or all of their debts. In most jurisdictions, bankruptcy is imposed by a court order, often initiated by the de ...

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 Consignment is a process whereby a person gives permission to another party to take care of their property while retaining full ownership of the property until the item is sold to the final buyer. It is generally done during auctions, shipping, ...

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. Trade credit has been identified as a critical source of short-term financing for listed manufacturing companies. A trade credit contract is a legally binding agreement between two parties that allows a buyer to purchase goods or services on account and pay the supplier at a later date

References

*Chludek, Astrid, K. (2010), p. 4
A note on the price of trade credit
{{Authority control Credit Accounting terminology Working capital management

Example

Alternatives

See also

References