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Trade Credit

The term ‘trade credit’ refers to an arrangement whereby the supplier sells raw materials, finished goods, or components, etc. to the buyer on credit and allows him to make payment within an agreed period, generally ranging for 30 days to 90 days. The availability of trade credit depends upon various factors such as nature and size of the firm, trade conditions, financial strength of the firm, credit policy of the supplier, etc.

Merits of Trade Credit. Trade credit as a source of short-term finance has the following benefits.

(i)    It is a very simple method of short-term financing and does not involve costs of legal papers, advertisement, etc.

(ii)    It does not require provision of any security of tangible assets with the suppliers.

(iii)    It is a flexible source of finance. The amount of trade credit could be adjusted as per changing needs of the buyer.

(iv)    The buyer is not required to pay any extra interest up to the agreed period fo credit. He only loses cash discount.

(v)    The period of credit depends upon the agreement between the supplier and the buyer. This period could be extended further on agreeing to pay some interest for the extended period.

Limitations of Trade Credit. Trade credit has the following limitations:

(i)    Only the buyers with financial reputations are allowed credit facility by the suppliers.

(ii)    The suppliers may charge higher prices when the customers want suppliers on credit.

(iii)    At times, the suppliers ask for bank guarantee or bill of exchange from the buyers. This might cause delays in getting trade credit.

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