trade credit

Examples of trade credit in the following topics:

• 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.

• Collecting Receivables

  • Collecting upon accounts receivable is the final step in the credit extension process, and arguably the most difficult.
  • By comparing this number to the number in the credit policy, a business can determine whether its policy is effective or not.
  • The accounts receivable days is important because investors utilize this measure to evaluate a firm's credit management policy.
  • Another way to evaluate a credit policy is to look at the receivable turnover ratio.
  • A company may protect against bad-debts losses by purchasing trade credit insurance.

• Days Sales Outstanding

  • The days sales outstanding figure is an index of the relationship between outstanding receivables and credit account sales achieved over a given period.
  • Generally speaking, though, higher DSO ratio can indicate a customer base with credit problems and/or a company that is deficient in its collections activity.
  • A low ratio may indicate the firm's credit policy is too rigorous, which may be hampering sales.
  • Higher days sales outstanding can also be an indication of inadequate analysis of applicants for open account credit terms.
  • Many financial reports will state Receivables Turnover defined as Net Credit Account Sales / Trade Receivables; divide this value into the time period in days to get DSO.

• 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

• Employment in Finance

  • Financial services encompasses a broad range of organizations that manage money, including banks, credit unions, credit card companies, insurers, consumer finance companies, stock brokerages, investment funds, some government sponsored enterprises, and other financial institutions, including peer-to-peer lending platforms.
  • Workers may be employed in a variety of functions by credit card issuers, such as customer service, foreign exchange service, high-profile trading, and airport currency exchangers.
  • Credit analysts work in a variety of institutions to assess the creditworthiness of firms, governments, or individuals for loans.
  • Sophisticated mathematical and technological developments have also advanced the field of quantitative analysis for those who work in investment management, risk management, derivatives pricing, algorithmic trading, and other areas that require the application of mathematics in finance.

• Tax Deductions

  • Nearly all jurisdictions that tax business income allow tax deductions for expenses incurred in trading or carrying on the trade or business.
  • Tax deductions and tax credits are often incorrectly equated.
  • While a deduction is a reduction of the level of taxable income, a tax credit is a sum deducted from the total amount of tax owed.
  • For example, a tax credit of $1,000 reduced taxes owed by $1,000, regardless of the marginal tax rate.
  • A tax credit may be granted in recognition of taxes already paid, as a subsidy, or to encourage investment or other behaviors.

• 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).

• 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.

• Market Actors

  • Other classes of intermediaries include: credit unions, financial advisers or brokers, collective investment schemes, and pension funds.
  • Exchange-traded funds are open-end funds or unit investment trusts that trade on an exchange.
  • An exchange-traded fund (ETF) is an investment fund traded on stock exchanges, much like stocks.
  • An ETF holds assets such as stocks, commodities, or bonds, and trades close to its net asset value over the course of the trading day.
  • ETFs are the most popular type of exchange-traded product.

• Defining Accounts Receivable

  • Accounts receivable represents money owed by entities to the firm on the sale of products or services on credit.
  • 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 the invoice within an established timeframe, which is called the credit terms or payment terms.
  • The receivables owed by the company's customers are called trade receivables.
  • The entry would consist of debiting a bad debt expense account and crediting the respective accounts receivable in the sales ledger.