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3 Things To Know About Trade Credit Definition | trade credit definition

What exactly is trade credit and how is it beneficial to businesses? In simple terms, trade credit is the credit extended to an individual or organization by one commercial entity to another when the products and services being offered are sold on credit. This credit facility enables one commercial entity to take advantage of another company's need for supplies. Trade credit also facilitates the instant sale of supplies by business organizations without immediate repayment.

There are numerous instances where trade credit terms are used. For example, in the procurement of raw materials, it is common to arrange for payment terms that provide merchants with a reasonable period of time for payment, after which the supplies are retained by the seller. The same approach is used when distributors are granted credit terms to purchase inventory from suppliers. In addition, credit terms are arranged between various suppliers when a company obtains goods in bulk. In such cases, suppliers agree to extend credits to companies until delivery of actual goods.

It should be noted that the terms of use of a product often determine the terms of trade credit definition. For instance, a credit facility may be granted to a small business to enable it to buy the required equipment. If the products are not suitable, the small business is not required to pay upfront. The same approach applies if the company has a list of suppliers who would be willing to extend credit terms.

A vital aspect of the definition of trade credit involves the fact that it is designed to help small businesses expedite cash flow. An example is buying materials used in production. If a company needs specific machinery to produce goods, it does not have the finances to purchase it before hand. However, if it were granted a trade credit facility, it would be able to purchase the necessary machinery at favourable terms. Such a facility would provide it with the needed money to purchase the required goods without incurring debts.

Another aspect of trade credit definition considers the requirement to repay the credit amount in a short-term or repayment period. The term of repayment is based on the nature of the product. For instance, goods that are used in production are required to be paid off within one year. On the other hand, raw materials purchased for use in production may be required to be paid off over time. Similarly, goods that are bought for consumption are required to be paid off in the short term.

In cases where the goods are purchased on the basis of trade credits and are not required to be paid back, the supplier will be granted a credit term of one year. The duration of the credit also depends on the quantity and quality of the good purchased. If the value of the product is above a certain price level, then the supplier is allowed to extend credit up to a particular level of the good's price. If the value of the good is below a particular price level, then the same goods will qualify for no credit.

To ensure favourable trade credit terms, it is essential that suppliers offer competitive rates. This is possible if the suppliers have access to base financial institutions that give them favourable rates. It is also advisable to buy products from these financial institutions because the rates offered by them are very low when compared to those offered by other financial institutions.

It is essential to buy goods from a supplier who offers trade credits. Failure to do so could result in the expiry of trade credits. Also, if the accounts of exporters are regularly monitored, the exporters will be able to monitor the progress and decline or increase trade credits accordingly. The exporter should therefore be able to predict the trend of the industry in terms of sales and purchases of goods that need trade credits in the future.

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