Trade Credit

Reviewed by Apoorva | Updated on Aug 27, 2020

What is Trade Credit?

Trade credit is an agreement made between two businesses where the customer can make purchases on the account without making cash payment upfront. The parties agree to the condition where the customer makes payments to the supplier at a later date, typically within 30, 60, or 90 days. The transaction will be recorded in an invoice.

Understanding Trade Credit

In simple terms, trade credit can be thought of as a 0% financing that increases a company's assets while deferring payments up to a specific value of goods and services. There is no interest payment involved in this kind of transaction. It comes as an advantage to the buyer. If the buyer can build trust and negotiate an even longer period for credit repayment, he will be in a greater advantage.

In certain cases, a business can obtain materials, manufacture the goods, and sell them before having to repay the seller. This provides a revenue stream that can cover the costs of goods sold.

Trade credit exists not only between two businesses located in the same city, but it can also exist in international business deals. The buyer who receives the trade credit will always be at the advantage of having greater cash flow.

Examples of Businesses Utilising Trade Credit

Walmart has taken advantage of the trade credit facility; it sought the sellers to pay retroactively for the inventory sold in the store-chain.

Accounting Trade Credit

Both the buyer and the seller are accounted for trade credit. However, the way they are accounted to may vary based on the accounting technique they use—cash accounting or accrual accounting. Accrual accounting requires the business to record the transaction at the time it takes place, whereas cash accounting requires businesses to record a transaction at the time of making payments.

Trade credit can make it difficult for the business to keep track of the transaction. There are high possibilities that a customer will default payment. Also, the seller may have to provide discounts while receiving payments, leading to receiving an amount that is lesser than the amount recorded in the accounts receivable.