Advantages of Trade Credit
The firm must balance the advantages of trade credit against the cost of forgoing a cash discount, the opportunity cost associated with possible deterioration in credit reputation if it stretches its payables, and the possible increase in selling price the seller imposes on the buyer. There are several advantages of trade credit as a form of short term financing. Probably the major advantage is its ready availability. The accounts payable of most firms represent a continuous form of credit. There is no need to arrange financing formally; it is already there. If the firm is now taking cash discounts, additional credit is readily available by not paying existing accounts payable until the end of the net period. There is no need to negotiate with the supplier; the decision is entirely up to the firm. In stretching accounts payable, the firm will find it necessary, after a certain degree of postponement, to negotiate with the supplier.
In most other types of short term financing, it is necessary to negotiate formally with the lender over the terms of the loan. The lender may impose restrictions on the firm and seek a secured position. Restrictions are possible with trade credit, but they are not nearly as likely. With other sources of short term financing, there may be a lead time between the time the need for funds is recognized and the time the firm is able to borrow them. Trade credit is a more flexible means of financing. The firm does not have to sign a note, pledge collateral, or adhere to a strict payment schedule on the note. A supplier views an occasional delinquent payment with a far less critical eye than does a banker or other lender.
The advantages of using trade credit must be weighted against the cost. As we have seen, the cost may be very high when all factors are considered, Many firms utilize other sources of short term financing in order to be able to take advantage of cash discounts. The savings in cost over other forms of short term financing,
however, must offset the flexibility and convenience of trade credit. For certain firms there are no alternative sources of short term credit.
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