Trade Credit: Meaning, Features, Advantages and DisadvantagesTrade credit is where one business provides a line of credit to another business for buying goods and services. For example, a garden landscaping business might use trade credit to buy materials for a landscaping project, buying on credit and promising to pay within a set term — usually 30 days. As a business, you can offer trade credit to other companies and also use trade credit facilities offered by other companies. Trade credit is less formal than a loan from a bank, though there are usually terms and conditions attached, including penalties and interest for late payments. Trade credit is a mutually beneficial arrangement — customers are able to buy goods on credit, and suppliers can attract more customers by not demanding cash up front. Trade credit advantages and disadvantages are different depending on whether your business is the buyer in the agreement and using trade credit, or a supplier of trade credit.
The Advantages & Disadvantages of Trade Credit
Any finance has three important parameters — amount of loan, rate of interest and time period of a loan. In this case, the amount of credit is the bill amount, the rate of interest is practically nil, and the period of credit is the credit period given in the terms of payment. Trade credit is also known as a spontaneous source of finance. It is a major source of working capital finance for most business whether small or big. Amount and period of trade credit are dependent on two things.
The extension of credit terms to buyers is a common practice in most industries. While it does disrupt the cash flow of a company, it is necessary to remain.
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There are various advantages of trade credit making it a favorite source working capital for all levels for buyers and promotional tool for suppliers. Most important benefit is that it has no explicit cost. Advantages of trade credit also include its effortless acquisition and easily maintainable. There are no legal instruments required to be signed which make it all the more flexible source of working capital finance. Trade Credit is considered as the cheapest form of working capital finance. It is not only the free source of finance but also gets a discount if paid before a certain period of time. If paid on the 10 th day, the buyer will get a discount on the bill as well as the free credit period of 10 days.
Every business owner would like to have all sales on a cash basis, but that's not always possible in a competitive marketplace. Sometimes, sellers need to offer sales on credit terms just to get customers to buy their products. Unfortunately, selling on delayed payment terms opens up an entirely new aspect of running a business: managing the extension of trade credit to customers. A customer will buy more of a supplier's products if they don't have to pay cash immediately for their purchases. The most common credit term offered by sellers is payment within 30 days. Rarely do you see credit terms extended beyond this time. The extension of credit terms tells the buyer that the seller considers them trustworthy and has confidence that they will pay their bills when they're due.