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Discuss the various merits and demerits of raising finance from Trade credit.
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Advantages of Trade Credit
Increased sales: A customer will buy more of a supplier's products if they don't have to pay cash immediately for their purchases.
Customer loyalty: 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. The buyer rewards the seller's vote of confidence by continuing to make purchases.
Competitive advantage: A seller who is able to offer trade credit to buyers has an advantage over his competitors, if they are not able to offer credit terms. This makes sense. Naturally, a buyer wouldprefer to purchase on credit terms than to pay cash for all of his purchases.
Disadvantages of Trade Credit
Negative effect on cash flow: The most immediate effect of trade credit is that sellers do not receive cash immediately for sales. Sellers have their own bills to pay and extending credit terms to buyers creates a hole in their companies' cash flow.
Must investigate creditworthiness of customers: Just like a bank, a vendor who extends credit to customers needs to analyze their credit ratings. This takes money and time. Obtaining business credit reports, such as Dun & Bradstreet, cost money, and making calls to check on references takes time. A vendor may need to hire an additional person who has credit analysis skills to help make the decisions about extending terms of payment.
Monitoring accounts receivable: Extending credit creates more outstanding accounts receivable, and someone needs to monitor these customers to make sure that they are paying on time. A company that is making its sales in cash does not have this problem.
Financing accounts receivable: The extension of credit terms to buyers means that the seller has to finance these receivables. A seller may have to lean on his own suppliers to receive trade credit, borrow on his bank line of credit or use the company's accumulated retained earnings. All of these methods have an inherent cost of capital.
Possibility of bad debts: Inevitably, the extension of trade credit will lead to some buyers not paying their debts. When this happens, an employee needs to spend time making collection calls to the late payers, and, eventually, the seller may need to write off the unpaid receivables and take a loss.
Increased sales: A customer will buy more of a supplier's products if they don't have to pay cash immediately for their purchases.
Customer loyalty: 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. The buyer rewards the seller's vote of confidence by continuing to make purchases.
Competitive advantage: A seller who is able to offer trade credit to buyers has an advantage over his competitors, if they are not able to offer credit terms. This makes sense. Naturally, a buyer wouldprefer to purchase on credit terms than to pay cash for all of his purchases.
Disadvantages of Trade Credit
Negative effect on cash flow: The most immediate effect of trade credit is that sellers do not receive cash immediately for sales. Sellers have their own bills to pay and extending credit terms to buyers creates a hole in their companies' cash flow.
Must investigate creditworthiness of customers: Just like a bank, a vendor who extends credit to customers needs to analyze their credit ratings. This takes money and time. Obtaining business credit reports, such as Dun & Bradstreet, cost money, and making calls to check on references takes time. A vendor may need to hire an additional person who has credit analysis skills to help make the decisions about extending terms of payment.
Monitoring accounts receivable: Extending credit creates more outstanding accounts receivable, and someone needs to monitor these customers to make sure that they are paying on time. A company that is making its sales in cash does not have this problem.
Financing accounts receivable: The extension of credit terms to buyers means that the seller has to finance these receivables. A seller may have to lean on his own suppliers to receive trade credit, borrow on his bank line of credit or use the company's accumulated retained earnings. All of these methods have an inherent cost of capital.
Possibility of bad debts: Inevitably, the extension of trade credit will lead to some buyers not paying their debts. When this happens, an employee needs to spend time making collection calls to the late payers, and, eventually, the seller may need to write off the unpaid receivables and take a loss.
Anonymous:
Woah! It's way too big
Copied or what ?
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4
The
1) It is an easy source of short term finance.
2) It helps business to focus on core activities.
The
1) It is difficult for new business to finance through trade credit.
2) It is an expensive source of payment, if payment is not made on due time.
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