Trade credit has various advantages, making it a favorite source of working capital for all levels for buyers and a promotional tool for suppliers. The 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 requirements for signature on legal instruments, which makes it all the more flexible source of working capital finance.
Advantages of Trade Credit
Trade Credit considers being the cheapest form of working capital finance. All other sources of working capital finance, such as bank overdrafts, cash credit, etc., have interest costs attached to them. Practically, there is no interest cost attached to trade credit, provided the dues are paid within the credit period provided by the supplier/ creditor.
(Refer: Cost of Trade Credit)
Discounts on Early Payments
It is not only a free source of finance but also gets a discount if paid before a certain period of time. Credit terms say “2/10 net 30”. If paid on the 10th day, the buyer will get a discount on the bill and a free credit period of 10 days.
The most important characteristic of trade credit is that it is effortlessly available to the business, and therefore it is widely utilized by managers. The purchase is an essential function of any business, and trade credit is processed while executing the function of purchase. As per the say, there is no special process to obtain this credit. All we have to do is to make payment a little later.
Accounting is an integral part of any business. Managing trade credit does not require too many additional efforts apart from normal accounting and administering the time of payment, which a business will do.
No Legal and Banking Botheration
Since no formal negotiable instrument is being executed, trade credit is free from any legal repercussions. Also, since there is no involvement of banks anywhere, there is no fear of the account going NPA – Non-Performing Asset.
In a competitive market, trade credit from the point of view of the supplier act as a promotion. Liberal the terms of trade credit, higher will be the sales. There is a direct correlation between the terms of credit and the sales generated by the supplier.
A liberal trade credit policy is one of the tools to penetrate the market.
It is pretty obvious that the credit allowed by the supplier is not a donation given to the buyer. The cost of extending credit is compensated by the higher prices the supplier charges. It is a win-win situation for the buyer as well as the seller. On the other hand, the buyer is also happy paying a little extra in the absence of cash availability with him. Almost no businesses run completely on cash.
Before forming any decision, it will be wise to look at the disadvantages of trade credit.
Advantages of Trade Credit
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