trade credit

(noun)

a form of debt offered from one business to another with which it transacts

Related Terms

Examples of trade credit in the following topics:

  • Trade Credit or Accounts Payable

    • Trade credit is the largest use of capital for a majority of B2B sellers; Accounts Payable is money owed by a firm to its suppliers.
    • 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 eight times the amount of capital invested by shareholders.
    • For many borrowers in the developing world, trade credit serves as a valuable source of alternative data for personal and small business loans.
    • There are many forms of trade credit in common use; often industry-specific.

  • Terms of Trade

    • Terms of trade credit include the amount of time allowable for payment to be received, including any potential discounts.
    • Credit terms are often quoted as "net X" with X being a certain number of days.
    • 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 another 30 days and pay the full invoice amount within 60 days.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.
    • Under this agreement, they are apparently taking a loss or disadvantageous position in this web of trade credit balances.
    • By tracking which customers pay, and when, the distributor can identify problems that are developing and take steps to reduce or increase its amount of trade credit.

  • Using the Receivables Turnover Ratio

    • The receivables turnover ratio, also called the debtor's turnover ratio, is an accounting measure used to measure how effective a company is in extending credit as well as collecting debts.
    • A high ratio implies either that a company operates on a cash basis or that its extension of credit and collection of accounts receivable is efficient; in contrast, a low ratio implies the company is not making the timely collection of credit.
    • $\dfrac{\text{Trade receivables}}{\text{Credit sales} \cdot 365} = \text{Average collection period in days}$
    • $\dfrac{\text{Trade payables}}{\text{Credit purchases} \cdot 365} = \text{Average payment period in days}$

  • Obtaining Credit

    • The credit card company uses the credit report, provided by the credit bureau, to determine if the lender is likely to pay back the loan.
    • Types of credit include: bank credit, consumer credit, public credit, and investment credit.
    • Credit is also traded in financial markets.
    • The purest form is the credit default swap market, which is essentially a traded market in credit insurance.
    • The term "credit reputation" can either be used synonymous to credit history or to credit score.

  • Credit Ratings

    • Credit ratings are determined by credit ratings agencies.
    • Results focus foremost on economics, specifically sovereign default risk and/or payment default risk for exporters (a.k.a. trade credit risk).
    • A credit score is primarily based on credit report information, typically from one of the three major credit bureaus: Experian, TransUnion, and Equifax.
    • Income is not considered by the major credit bureaus when calculating a credit score.
    • The credit bureaus all have their own credit scores: Equifax's ScorePower, Experian's PLUS score, and TransUnion's credit score, and each also sells the VantageScore credit score.

  • Balance of Trade

    • A positive balance is known as a "trade surplus," if it consists of exporting more than is imported; a negative balance is referred to as a "trade deficit" or, informally, a "trade gap."
    • The balance of trade is sometimes divided into a goods and a services balance.
    • This cannot be true, because all transactions involve an equal credit or debit in the account of each nation.
    • Factors that can affect the balance of trade include:
    • In addition, the trade balance is likely to differ across the business cycle.

  • Trade-Off Consideration

    • Trade-off considerations are important because they take into account the cost and benefits of raising capital through debt or equity.
    • Therefore, a firm that is optimizing its overall value will focus on this trade-off when choosing how much debt and equity to use for financing.
    • The reason they do not is because of the risk of bankruptcy and the volatility that can be found in credit markets—especially when a firm tries to take on too much debt.
    • Therefore, trade off considerations change from firm to firm as they impact capital structure.
    • Describe the balancing act between debt and equity for a company as described by the "trade-off" theory

  • Setting a Credit Policy

    • To establish a credit policy, a company must establish credit standards, credit terms, and a collection policy.
    • Management must decide on credit standards, which involves decisions on how much credit risk to assume.
    • Another important factor in determining credit standards involves a company evaluating the credit worthiness, or credit score, of an individual or business.
    • To reduce its risk, the seller may perform a credit check on the buyer or require the buyer to put up collateral against credit extended.
    • Trade discount (usually given when the buyer agrees to perform some function).

  • Classifying Receivables

    • Receivables can be classified as accounts receivables, trade debtors, bills receivable, and other receivables.
    • Accounts receivable represents money owed by entities to the firm on the sale of products or services on credit.
    • In turn, the customer must pay it within an established time frame, which is called the credit terms or payment terms.
    • Trade receivables are the receivables owed by the company's customers.
    • Distinguish between accounts receivable, trade debtors, bills receivables and other receivables

  • Default Risk

    • Default risk (or credit risk) of a bond refers to the risk that a bond issuer will default on any type of debt by failing to make payments which it is obligated to do.
    • To reduce the bondholders' credit risk, the lender may perform a credit check on the prospective borrower, may require the issuer to take out appropriate insurance, such as mortgage insurance or seek security or guarantees of third parties, besides other possible strategies.
    • Bank lenders, deposit holders (in the case of a deposit taking institution such as a bank), and trade creditors may take precedence.
    • Credit default swaps are an instrument to protect against default risk.
    • Higher credit default swap prices mean that investors perceive a higher risk of default.