There are many forms of trade credit in common use. Various industries use various specialized forms. They all have, in common, the collaboration of businesses to make efficient use of capital to accomplish various business objectives.
For example: Let's just say you operate an ice cream stand under a franchise which agrees to provide you with ice cream stock under the terms Net 60 with a ten percent discount on payment within 30 days, and a 20 % discount on payment within 10 days. This means that you have 60 days to pay the invoice in full. If you sell enough ice cream at your markup within a week, then you can dispatch a cheque for 80 % of the invoice, and make an extra 20 % on the ice cream sold. However, if sales are slow, leading to a month of low cash flow, then you may decide to pay 90 % within 30 days or use the money another 30 days and pay the full invoice amount within 60 days.
The ice cream distributor can do the same thing. Receiving trade credit from milk and sugar suppliers on terms of Net 30, 2 % discount, if paid within ten days, means he is apparently taking a loss or disadvantageous position in this web of trade credit balances. Why would he do this? First, remember he has a substantial markup on the ingredients and other costs of production of the ice cream he sells to you. There are many reasons and ways to manage trade credit terms for the benefit of a business. The ice cream distributor may be well capitalized either by steady profits or recent new investments and may be looking to expand his markets. In this case he is being aggressive in attempting to locate new customers or to help them get established. Having experienced a few customers going out of business from cash flow instabilities he has decided on financial terms to accomplish two things:
Definition: An arrangement to buy goods or services on account, that is, without making immediate cash payment
For many businesses, trade credit is an essential tool for financing growth. Trade credit is the credit extended to you by suppliers who let you buy now and pay later. Any time you take delivery of materials, equipment or other valuables without paying cash on the spot, you're using trade credit.
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