Trade credit is one of the most important forms of financing for companies. In most European countries, more than 80 % of daily business is financed via trade credit. In Germany, this figure adds up to 94 % of daily business transactions, in Poland up to 92 % (Table 1). Moreover, trade credit represents up to 35 % of the total assets of companies. (Euler Hermes S.A., 2006). Additionally, in more than 95 % of all Belgian companies, accounts payables are present (Huyghebaert, 2006). Ng, Smith, & Smith, (1999) report that during the 1990s, commercial debt adds up to about 2.5 times the amount of the combined value of public debt and primary equity issues.
Economically seen, these figures show the importance of trade credit. Considering, however, the high implicit interest rates of trade credit compared to institutional credit,
this raises questions: Why is trade credit used, when at the same time lower interest rates for financing could be obtained by specialized institutions? What kind of advantages do suppliers receive by allowing their customers to pay after delivery (i.e. trade credit)?
Many theories on trade credit are to be found in literature. This paper targets on showing the most important theories, concentrating on those which explain the wide extension of trade credit in the economy.
Table of Contents
List of abbreviations
List of figures and tables
1 Introduction
1.1 Problem Definition and Objective
1.2 Course of the Investigation
2 Trade credit
2.1 Basic information about trade credit
2.2 Pricing
3 The use of trade credit from different perspectives
3.1 Supplier’s side
3.1.1 Increase in sales
3.1.2 Financing advantage
3.1.3 Customer relationship management
3.2 Buyer’s side
3.2.1 Insurance of liquidity
3.2.2 Transactions cost theory
3.2.3 Accessibility
3.2.4 Product Quality control
4 Conclusion
Reference List
Appendix
List of abbreviations
1. Cash On Delivery (COD)
2. Cash Before Delivery (CBD)
3. Metropolitan Statistical Area (MSA)
List of figures and tables
Illustration 1: Percentage of overall sales on trade credit
1 Introduction
1.1 Problem Definition and Objective
Trade credit is one of the most important forms of financing for companies. In most European countries, more than 80 % of daily business is financed via trade credit. In Germany, this figure adds up to 94 % of daily business transactions, in Poland up to 92 % (Table 1). Moreover, trade credit represents up to 35 % of the total assets of companies. (Euler Hermes S.A., 2006). Additionally, in more than 95 % of all Belgian companies, accounts payables are present (Huyghebaert, 2006). Ng, Smith, & Smith, (1999) report that during the 1990s, commercial debt adds up to about 2.5 times the amount of the combined value of public debt and primary equity issues.
Economically seen, these figures show the importance of trade credit. Considering, however, the high implicit interest rates of trade credit compared to institutional credit, this raises questions: Why is trade credit used, when at the same time lower interest rates for financing could be obtained by specialized institutions? What kind of advantages do suppliers receive by allowing their customers to pay after delivery (i.e. trade credit)?
Many theories on trade credit are to be found in literature. This paper targets on showing the most important theories, concentrating on those which explain the wide extension of trade credit in the economy.
1.2 Course of the Investigation
In the first part, this paper gives a brief overview of trade credit and its pricing. Afterwards, the most common theories of trade credit are shown from the supplier- and customer side respectively. The advantages for the supplier are categorized into: increasing sales, financing advantage theories, and customer relationship management. For the customer on the other hand, it is categorized into the insurance of liquidity, transaction cost theory, the accessibility of financing and the quality control. The paper closes with a conclusion, which gives a summary over the most important aspects.
2 Trade credit
2.1 Basic information about trade credit
Each time a company allows his customers to pay after the delivery of goods, trade credit is granted to the buyer. Depending on the perspective, either supplier or buyer, trade credit appears as accounts receivable or accounts payable on the balance sheet. It represents one of the most important sources of short-term financing. Trade credit stands for about 50 % of short-term debt in medium-sized UK-, and small US firms (Cuñat, 2007). Moreover, the use of advanced payment also includes a form of trade credit. If the buyer pays his deliverer before receiving goods, he grants credit to him. This sort of credit however is less frequently used. It appears in the shipbuilding or aircraft industry (Ferris, 1981). Cash on delivery (COD) or Cash before delivery (CBD) are the most common alternatives concerning payment terms.
According to Wilson & Summers (2002), firms that are extending trade credit to their customers, often use trade credit themselves as a part of their own financing. This makes them to suppliers and customers at the same time, dependent on the perspective. Moreover, they state that trade credit is a measure to provide financially constrained firms with liquidity by companies that do not have problems in raising their funds. Trade credit, thus, is given down the complete value chain.
Trade credit is either one - part or two-part. The most common example for a two-part contract in the United States is 2-10 net 30 (Ng, et al., 1999). The three key elements of a two-part contract are the following: the discount for early payment, the early payment period and the net date. 2-10 net 30 means that if the customer pays within 10 days, he may subtract 2 % of the price. Otherwise he has to pay the full amount within 30 days. After the 30 days, the buyer is in default.
A one-part term however, might look as follows: net 30. In contrast to the two-part terms, it does not contain either a discount or an early payment period; it simply defines the date when the payment is due (i.e. 30 days after the invoice date).
The specific terms of trade credit vary due to multiple factors like country or industry. Wilson & Summers (2002) find that the regular payment period in the UK varies from less than 7 to more than 120 days.
2.2 Pricing
The interest rate of trade credit is not cognizable at first sight. The offered discount in two-part terms might look tiny but if the buyer does not take advantage of it, it adds up to a high annual interest rate. This interest rate commonly amounts to more than 40 % per year, some specific trade credit contracts might even cause more than 300 % p.a (e.g. 8-30 net 50). The reason lies within the structure of two-part terms. The period until the discount date might be seen as an interest free loan. Considering the common trade credit contract of 2-10 net 30, the buyer in fact receives a loan at a 2 % rate for 20 days. Projected on one year, the interest rate accounts for roughly 44 %, which is much higher than comparable bank credit.
Cuñat (2007), however, points that one-term contracts may also contain an interest rate, as it might be added to the price in advance. The same goes for the early-payment period of two-part terms. These costs however, obviously are not visible for outsiders.
Moreover, Cuñat (2007) states other reasons for the high costs of trade credit. First, if the customer is facing severe liquidity problems, the supplier would provide him with extra liquidity. This is due to the high costs for the supplier arising from a buyer’s bankruptcy. As suppliers foresee this possible event, they add an insurance premium, compensating them for their higher costs. According to Cuñat, late payment is the main instrument for this form of liquidity provision. Second, a default premium is also added, compensating the supplier for his higher risk. Due to their possibility to cut off supply, suppliers are able to grant credit when banks are not. As they lend on a basis of not foreseeable returns, suppliers are exposed to a higher risk.
The subjective sensation of the interest rate of trade credit might be completely deviant for different customers. According to Petersen & Rajan (1994), suppliers do not tailor trade credit contracts for different customers. After the decision to grant credit, terms are geared to industry practice. As a result, creditworthy customers might feel that their interest rate is high, whereas for customers with a low degree of creditworthiness this very contract might be less expensive than other forms of financing.
3 The use of trade credit from different perspectives
3.1 Supplier’s side
Suppliers might use trade credit due to multiple important reasons. Using this form of trade credit might not only be an effective way of raising sales, it is also an important tool in order to deepen the customer relationship. Moreover, suppliers have specific advantages which allow them to grant trade credit when financial institutions deny it. These advantages are described in 3.1.2, “financing advantage”.
3.1.1 Increase in sales
Companies might use trade credit as a measure to raise their sales. Petersen & Rajan (1997) tested this by examining the accounts receivable:sales ratio under varying conditions. A company which has experienced an increase in its sales granted only insignificantly more trade credit to its customers. A company with declining sales in the past however, increases granted trade credit.
The effective price of a product is influenced by trade credit. It is, thus, one essential part of a company’s pricing policy. (Schwartz, 1974). Firms can use the various options in trade credit terms in order to positively influence their sales and so to strengthen the own position in a competitive market. By offering attractive discounts or granting a long payment period, suppliers increase their own attractiveness for customers. Pike, R., Cheng, N., Cravens, K., & Lamminmaki, D. (2005) find that trade credit is more intended to increase sales than to cause prompt payment, underlining the importance of trade credit as a sales tool.
Assuming that price discrimination is forbidden by law, trade credit might be an effective measure of fulfilling the different needs of different customers. A company could be willing to offer its best customers special prices. As this might not be allowed, offering attractive discounts within the trade credit terms could be a way to circumvent the legal restrictions. It has to be considered however, that also price discrimination via trade credit might be forbidden due to legal restrictions (Huyghebaert, 2006). If specifying credit terms to specific customers is not allowed, companies could arrange their credit terms in a way that is legally allowed and still effectively price discriminating. If trade credit is rather costly, firms that are not financially constrained probably will not take advantage of this sort of trade credit. Other channels may be less costly for them. Financially constrained firms however might still need to use trade credit, as other options are even more costly or not available. Moreover, late payment without penalty or similar arrangements are very difficult to observe for an outsider.
Petersen & Rajan (1997) tested the effect of price discrimination on the trade credit decision by comparing the amount of trade credit granted to the gross profit margin. They find that the higher the gross profit margin of a firm is, the higher is the amount of trade credit that is given to the customers. As with a high gross profit margin companies have a higher incentive to sell, this data supports price discrimination being an important reason for the use of trade credit.
3.1.2 Financing advantage
Compared to banks or other institutional borrowers, the supplier might have a number of advantages that allow him to offer credit to the buyer when bank credit is denied. In literature, these advantages are known as the financing advantage theories of trade credit.
First, suppliers collect information according to which the creditworthiness of the buyer might be calculated during regular business relationship. Financial institutions however must specially investigate relevant data. This way of retrieving information leads to a cost and time advantage in information collection compared to financial institutions (Petersen & Rajan, 1997; Wilson & Summers, 2002). Suppliers extending trade credit on a two-term basis might find their customers not benefitting of the discount date. With respect to the high implicit interest rate after the discount date, this might be interpreted as a signal for a potential decrease of creditworthiness. This is supported by the survey of Huyghebaert (2006). The data shows that buyers working frequently with their supplier receive more trade credit.
Second, suppliers might better force customers to pay for received goods. Especially if the buyer does not have many alternatives to his supplier, the menace of refusing to supply the customer with goods might be a very useful mechanism to ensure payment of debts. Cuñat (2007) speaks of links between the supplier and his customer. The tighter these links are, the more costly it is for both buyer and supplier to replace one or the other. In his paper, Cuñat examines the relationship between trade credit and the degree of product specialization. He finds that the higher the product is specialized, the more trade credit is extended to the buyer. Companies, whose input products are highly specialized, are likely to have less available suppliers. The latter are able to extend more trade credit for their possibility to cut off supply would expose the buyer to substantial problems. In an economic model of Bolton & Scharfstein (1990), a company is exposed to having just one financing company. In this case, refusing to refinance the customer would lead to bankruptcy as soon as new capital is needed. In reality although, a comparable situation might not be very realistic, however this is close to the idea of buyers using highly specialized input products.
Additionally, according to Petersen & Rajan (1997), banks might by law be restricted in refusing financing, whereas suppliers do not have any similar restrictions. This makes the threat of cutting the supply of goods even more credible, giving suppliers another advantage compared to financial institutions.
The advantage of forcing customers to pay however might be at stake if the supplier himself is in financial distress. The threat of cutting down supply is less credible if the supplier is facing economical problems. This idea is supported by the data of Petersen & Rajan (1997). The survey shows that firms with negative income and a negative sales growth tend to extend more trade credit. According to their paper, this might be “involuntary” (p. 675), as debtors could be less willing to repay if the threat of cutting down supply is less credible due to financial problems of the supplier.
Third, suppliers usually have a well developed selling network, meaning that one product is not produced for one single customer. This gives them an advantage in salvaging value compared to financial institutions. If a customer defaults, the supplier can recollect the product and resell it to another customer in his selling network. This possibility obviously depends on the degree to which the product is worked by the customer. Huyghebaert (2006) supports this idea, as her survey finds that in industries with low turnover rates of raw materials, suppliers extend more trade credit. Given the fact, that a low turnover rate increases the product value as a collateral, this gives credibility to this part of the financing advantage theory.
Franks & Sussman (2005) state the possibility of using a so called “Retention of Title” clause in the sale contract. In the event of insolvency, this clause allows the supplier to recover the on trade credit supplied goods. According to their paper, this is only possible, if “the goods are still distinguishable from other suppliers’ goods” (Franks & Sussman, 2005). Moreover, Franks & Sussman examine the question of whether trade credit is extended in times of financial distress. They find evidence that if a company is seen as being in financial distress by their bank, suppliers provide more trade credit. According to their survey, suppliers assign between 11.1 % and 32.6 % more trade credit, while bank credit decreases by at least one third. Pursuant to Cuñat (2007), Franks & Sussman provide the “equity-like stake” in the buyer as a potential explanation for this phenomenon.1
3.1.3 Customer relationship management
Considering the supplier, trade credit might be an effective possibility of improving his customer relationship management, with the ultimate goal of developing an “implicit equity stake” (Wilson & Summers, 2002, p. 318) in the customer. Cuñat (2007) states the forward-looking characteristic of trade-credit, whereas bank credit is backward- looking. This is mainly important for start-ups which might face difficulties in obtaining credits from financial institutions, as they are not able to provide much information of their history in order to calculate creditworthiness. Suppliers give trade credit on the basis of future returns, so young companies with a high growth-potential could benefit from trade credit. On the other hand, the supplier also benefits, as he supports companies during their critical start-up time. This might contribute to developing an intensive relationship to this customer. Moreover, the supplier could also benefit of a potential customer growth in the future.
Thinking of the growing intensity of a supplier-customer relationship with the time, the importance of winning customers at an early stage of their business existence becomes clear. First, at the beginning of their business life, potential customer might not have many alternatives in financing themselves. This clearly reduces the competition in gaining this firm as a customer. Second, the later a supplier tries to gain a new customer, the more intense will be the relationship between this very customer and a different supplier. Growing intensity of a business relationship implies also higher costs of switching to another supplier. It is, thus, easier to attract customers at an early stage. Petersen & Rajan (1997) state that suppliers extend more trade credit to customers with negative profits but positive sales growth. Hence suppliers seem to grant trade credit to customers with a good business perspective for the future. Moreover, the smaller the current profit is, the more trade credit is given to this customer. (if sales growth is positive).
It should not be forgotten that Trade credit affects the relationship between suppliers and customers in both directions. Also customers benefit from more intensive links to their supplier, as the latter will probably provide them with extra liquidity in the case of unexpected liquidity shocks (See chapter 2.2 Pricing).
3.2 Buyer’s side
Trade credit as a way to finance the company is one of the most important reasons why trade credit is used. Moreover, liquidity protection, the transaction cost theory and the possibility of controlling bought goods are also important. These theories are introduced in the following part.
3.2.1 Insurance of liquidity
Always assuring sufficient liquidity should be one of the most important goals for a company, as illiquidity would cause insolvency. Trade credit is an effective way of liquidity provision, as the effect of it is delayed payment of already received goods. A company has hence the possibility of buying goods when it would not be able to do so under CBD or COD terms. Especially young firms may not yet have steady sales figures and hence steady cash flow, so trade credit is important for them in order to secure liquidity. Start-ups, thus, tend to use more trade credit. This is supported by the survey of Huyghebaert (2006) that shows a decrease of accounts payables for Belgian companies with increasing age.
3.2.2 Transactions cost theory
According to Ferris (1981), trade credit might be used as a possibility to facilitate the exchange of goods between two firms and to reduce the costs arising from the uncertainty of delivery. By using trade credit, the buyer is able to separate the delivery of goods from the payment of these goods. What is normally one transaction (goods for money) is now divided into two different transactions (goods for loan; loan for money). These two transactions are needed to complete the delivery process.
The uncertainty of delivery leads to one major problem for the buyer. It might not be clear when and how much of the ordered product is delivered by the supplier. Thinking of immediate payment, this would force the buyer to always hold a sufficient amount of money on stock, allowing him to be able to pay for the goods as soon as they are delivered. This very capital obviously cannot be used in any other way, giving the buyer opportunity costs in the form of not realized interests.
The use of trade credit allows the buyer to predefine fixed dates of payment, changing the uncertain dates of payment “into a sequence that can be known with greater certainty”. (Ferris, 1981, p. 244). This sequence could be a month, or one quarter, during which all obligations are cumulated and paid at the end of this period. Moreover, Ferris states that without the uncertainty of delivery, the reason for precautionary money holdings is obsolete, releasing formerly bounded capital. This release eliminates the opportunity costs of forgone interests.
Emery (1987) sees another aspect of the transaction cost theory. In industries which are exposed to heavy seasonalities in demand, trade credit is a possibility to both suppliers and customers to reduce warehousing costs. By receiving a credit line from his supplier, the customer is able to order directly on demand. For this reason, he will be able to reduce warehousing costs.
Companies might have an interest in maintaining a stable production which could lead into a surplus of products in times of lower demand. Petersen & Rajan state that lowering prices in order to increase demand and to decrease stock inventory might be linked to menu costs and to a loss in discretionary ability. By granting credit to the customers, the company might be able to reduce the storage of products and by this means to reduce warehousing costs.
In their survey, Wilson & Summers (2002) find evidence for the transaction cost theory. Buyers, who order frequently at one supplier, receive longer credit periods. According to Huyghebaert (2006), this can be seen as a support of the idea that trade credit reduces transaction costs.
In her own survey, Huyghebaert (2006) examines the relationship between the turnover rate of raw materials and the use of trade credit. She found a positive relationship between these two information meaning that companies with a high turnover rate of raw materials use more trade credit. Huyghebaert concludes that firms collect obligations in order to reduce transaction costs of paying bills.
3.2.3 Accessibility
In literature, trade credit is seen as a possibility for the buyer to raise his capital when his access to financial institutions is constraint. “A major reason for using trade credit, is to overcome financial constraints” (Huyghebaert, 2006, p. 306).
Petersen & Rajan (1997) also examine the question of whether firms use more trade credit when being credit constrained by their financial institutions. They find that the length of the relationship between buyer and financial institution is negatively correlated to the use of trade credit. Moreover, they state that companies which do not use their complete credit line, use less trade credit. The survey shows an increase of accounts payable by over 3 % of the company’s assets, when the relationship between the financial institution and the buyer lasts for 10 years after the first contact. According to Petersen & Rajan (1997) both examinations can be interpreted as support for trade credit and bank credit being substitutes of each other. Moreover, their survey shows that companies in MSAs (Metropolitan Statistical Areas) have a higher accounts payable to total assets ratio. Given the fact that in MSAs, financing via bank credits is less commonly spread, this result is interpreted as support for trade credit being a way to substitute institutional financing.
In their paper, Fisman & Love (2003) examine the question of whether the financial market development influences the amount of trade credit used by companies. The paper shows evidence for a negative correlation between financial market development and trade credit as a financing tool for companies. Hence, in countries with less developed financial markets, more trade credit is used. Fisman & Love conclude that trade credit, thus, substitutes institutional credit if the credit demand of the companies cannot be satisfied by the institutional lenders.
Likewise, Huyghebaert supports the idea of trade credit substituting bank credit for financially constrained companies as stating the following: “start-ups that pay a higher price for their bank debt rely more on commercial debt.” (Huyghebaert, 2006, p. 310)
Obviously, the foregone conclusions raise the question why a supplier would offer credit to a company which has been denied for bank credit. This question is discussed in a different chapter of this paper (See chapter 3.1.3, financing advantage).
3.2.4 Product Quality control
For the buyer, trade credit might be an important tool in order to ensure the quality of his products. As reported by Long, M., Malitz, I., & Ravid, S. (1993, p. 121) “trade credit allows buyers to assess quality prior to payment”. In their survey, they find a positive relationship between the length of the production cycle and the amount of trade credit extended. Longer production cycles are seen as a hint for higher quality products. This strengthens the theory of product quality control as for customers buying high quality products, the quality control is of great importance.
Pursuant to Long et al. (1993), companies already possessing a good reputation, do not need to extend trade credit as a signal for their good quality. In a reverse conclusion, it follows that small firms without a good reputation, might be forced to use trade credit as a quality signal to their customers. Therefore, it is likely that small firms use more trade credit. In their survey, Long et al. find evidence that this is indeed the case, supporting the idea of the product quality control theory of trade credit. According to their survey, one major advantage of trade credit compared with money-back guarantees or warranties lies in the contrary onus of proof. Having a money-back guarantee or a warranty, the buyer must prove that the received product quality differs from the ordered quality. On the contrary, trade credit enables the buyer to pay only if the product fulfills the contractual conditions. Moreover, trade credit protects the buyer from the bankruptcy risk of the supplier, as the payment is due after delivery. This is an aspect which might be of higher importance for suppliers of start-up companies as they are exposed to a high risk of bankruptcy. According to a study of Dun & Bradstreet in 1994, more than 50 % of all bankruptcies in 1993 happened in the first 5 years of business.
Ng, C., Smith, J., & Smith, R. (1999) state that suppliers offer longer credit periods to international customers. As this group of customers is likely to be far away, the delivery time is hence longer than for national customers. Due to the longer distance, international customers need more time to control the goods. Allowing them longer credit periods can, thus, be interpreted as a support of the product quality control.
The survey of Huyghebaert (2006) also shows evidence for the product quality theory. Firms investing frequently in intangible assets use more trade credit than others. According to her survey, Huyghebaert concludes that these firms are highly specialized, needing high quality products. The need of quality control and the use of trade credit are hence positively correlated, strengthening the product quality theory.
4 Conclusion
Trade credit is an important part of daily business for the supplier as well as for the customer. It has various effects for both sides which are important in different stages of a company’s life. Young firms might heavily benefit of being financed by their supplier. Firms that have a new supplier are able to control the quality without being exposed to not controllable risks. The uncertainty of delivery of bought products can be avoided. Moreover, trade credit can be used to always maintain a sufficient amount of liquidity. For the supplier on the other hand, trade credit might be helpful to raise the sales. He is able to extend trade credit where banks and other financial institutions are not. Due to this, customers that would not be financed by their bank are able to buy goods and to consume.
The last 2 years have been heavily affected by the economic crisis. The extension of bank credit seems to be decreasing. Firms are experiencing heavy problems in financing their daily business or receiving credits in order to invest in the own company. A direct consequence for numerous companies are liquidity problems. Firms hence might be using trade credit as a substitute for bank credit especially during the credit crunch. As it was shown in the literature before, in times of tight money, the use of trade credit increases. (Nilsen, 2002) Nevertheless, there has been no empirical survey on the recent financial crisis. Due to the strong consequences, it would be interesting to see further research concerning this special topic.
Due to all its different functions, it can be concluded that trade credit is a very helpful and multifunctional mechanism in the economy. Concerning the vast amount of daily business activities that are financed via trade credit, it can be regarded as one of the key elements in the economy.
Reference List
Bolton, P., & Scharfstein, D. (1990, March). A Theory of Predation Based on Agency Problems in Financial Contracting. American Economic Review, 80 (1), 93.
Cuñat, V., (2007, March). Trade Credit: Suppliers as Debt Collectors and Insurance Providers. Review of Financial Studies, 20 (2), 491-527.
Dun & Bradstreet (1994), The Failure Record (Annual publication)
Euler Hermes S.A. (2006). An Independent Research Study of 2,000 Businesses in 10 European Economies. Retrieved September 2, 2009, from Euler Hermes SA website: http://www.eulerhermes.com/en/documents/studybrochurecreditmanagement.pdf/studyb rochurecreditmanagement.pdf
Ferris, J. (1981, May). A Transaction Theory of Trade Credit Use. Quarterly Journal of Economics, 96 (2), 242-270.
Fisman, R., & Love, I. (2003, February). Trade Credit, Financial Intermediary Development, and Industry Growth. Journal of Finance, 58 (1), 353-374.
Franks, J., & Sussman, O. (2005, March). Financial Distress and Bank Restructuring of Small to Medium Size UK Companies. Review of Finance, 9 (1), 65-96.
Huyghebaert, N. (2006, January). On the Determinants and Dynamics of Trade Credit Use: Empirical Evidence from Business Start-ups. Journal of Business Finance & Accounting, 33 (1/2), 305-328.
Long, M., Malitz, I., & Ravid, S. (1993, Winter 1993). Trade Credit, Quality Guarantees and Product Marketability. FM: The Journal of the Financial Management Association, 22 (4), 117.
Maksimovic, V. & Titman, S. (1991, March). Financial Policy and Reputation for Product Quality. Review of Financial Studies, 4 (1).
Ng, C., Smith, J., & Smith, R. (1999, June). Evidence on the Determinants of Credit Terms Used in Interfirm Trade. Journal of Finance, 54 (3), 1109-1129.
Nilsen, J. (2002, February). Trade Credit and the Bank Lending Channel. Journal of Money, Credit & Banking, 34 (1), 226-253.
Petersen, M., & Rajan, R. (1994, March). The Benefits of Lending Relationships: Evidence from Small Business Data. Journal of Finance, 49 (1), 3-37.
Petersen, M., & Rajan, R. (1997, Fall 97). Trade credit: theories and evidence. Review of Financial Studies, 10 (3).
Pike, R., Cheng, N., Cravens, K., & Lamminmaki, D. (2005, June). Trade Credit Terms: Asymmetric Information and Price Discrimination Evidence From Three Continents. Journal of Business Finance & Accounting, 32 (5/6), 1197-1236.
Wilner, B. (2000, February). The Exploitation of Relationships in Financial Distress: The Case of Trade Credit. Journal of Finance, 55 (1), 153-178.
Wilson, N., & Summers, B. (2002, April). Trade Credit Terms Offered by Small Firms: Survey Evidence and Empirical Analysis. Journal of Business Finance & Accounting, 29 (3/4), 317.
Appendix
Table 1:
illustration not visible in this excerpt
Source: A study by Euler Hermes S.A.; conducted by the Credit Management Research Center, University of Nottingham, 2006
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Frequently asked questions
What is the main topic of this document?
This document is a language preview related to trade credit, its uses from different perspectives (supplier and buyer), and its pricing.
What are the main topics covered in the table of contents?
The table of contents outlines the following key topics: introduction (problem definition and objective, course of investigation), trade credit (basic information and pricing), the use of trade credit from different perspectives (supplier and buyer sides), conclusion, reference list, and appendix.
What is "trade credit" as defined in the document?
Trade credit is when a company allows its customers to pay after the delivery of goods. From the supplier's perspective, it's accounts receivable; from the buyer's, it's accounts payable. It's a significant source of short-term financing.
What are some common trade credit terms?
Common trade credit terms include "2-10 net 30" (2% discount if paid within 10 days, otherwise full amount due in 30 days) and "net 30" (full amount due in 30 days).
Why might a supplier offer trade credit?
Suppliers might offer trade credit to increase sales, as a financing advantage (they may have better information or enforcement capabilities than banks), and as a customer relationship management tool.
How can trade credit increase sales?
Trade credit can be used as part of a company's pricing policy, offering discounts or longer payment periods to attract customers and strengthen their market position. It can also be a means of price discrimination where direct price changes are not permitted.
What are the "financing advantage" theories of trade credit?
Financing advantage theories suggest that suppliers have advantages over banks in offering credit because they collect information during regular business, can enforce payment more effectively (e.g., by cutting off supply), and may be able to salvage value from repossessed goods more easily.
How does trade credit relate to customer relationship management?
Trade credit can help suppliers develop an "implicit equity stake" in the customer, particularly start-ups. By providing credit early on, suppliers can build a strong relationship and benefit from the customer's future growth.
Why might a buyer use trade credit?
Buyers use trade credit for insurance of liquidity, to reduce transaction costs, for accessibility when bank credit is constrained, and for product quality control (assessing quality before payment).
How does trade credit provide "insurance of liquidity"?
Trade credit allows buyers to delay payment, enabling them to purchase goods even when immediate payment is not possible, especially crucial for young firms with unstable cash flow.
What is the "transactions cost theory" of trade credit?
The transactions cost theory posits that trade credit facilitates the exchange of goods by separating delivery from payment, reducing uncertainty and the need for precautionary money holdings. It can also help reduce warehousing costs by allowing customers to order directly on demand.
How does trade credit relate to a buyer's access to financial institutions?
Trade credit serves as a substitute for bank credit, especially when access to financial institutions is constrained. Companies denied bank loans may rely more heavily on trade credit from suppliers.
How does trade credit enable product quality control for the buyer?
Trade credit allows buyers to assess the quality of goods before paying for them. This is particularly important for high-quality products and new suppliers with unproven reputations.
What is the conclusion of the document?
The document concludes that trade credit is a multifunctional mechanism in the economy, benefiting both suppliers and customers in various ways, particularly in times of economic crisis or limited access to bank credit. It is viewed as a key element in the economy due to the amount of business activities it finances.
- Citation du texte
- Christian Eberhard (Auteur), 2009, Why do firms use so much trade credit?, Munich, GRIN Verlag, https://www.grin.com/document/263141
