Trade Credit as Source of Finance

Meaning of Trade Credit

Trade credit means credit granted to manufacturers and traders by the suppliers of raw material, finished goods, components, etc. Such credit appears in the records of the buyer of goods as ‘sundry creditors’ or ‘accounts payable’. Usually it is for 30 to 90 days credit.

This type of credit does not make the funds available in cash but it facilitates purchases without making immediate payment which amounts to funding it by suppliers. Terms of trade credit may vary from one industry to another and from one person to another or there can be different credit terms to different customers.

Merits of Trade Credit

1. Convenient and continuous source:

Trade credit is a convenient and continuous source of funds.

2. Readily available:

Trade credit may be readily available in case the credit worthiness of the customers is known to the seller.

3. Promote the sales:

Trade credit helps to promote the sales of an organisation.

4. Helpful to maintain inventory:

If an organisation wants to increase its inventory level in order to meet expected rise in the sales volume in the near future, it may use trade credit to, finance the same;

5. No charge on assets:

It does not create any charge on the assets of the firm while providing funds.

Limitations of Trade Credit

1. Overtrading:

Availability of easy and flexible trade credit facilities may induce a firm to indulge in overtrading, which may add to the risks of the firm.

2. Limited amount:

Only limited amount of funds can be generated through trade credit.

3. Costly source:

It sometimes proves to be a costly source of funds.