Short Term Financing: By short term financing we mean “the
amount of fund which is originally scheduled for repayment in one year or less
than one year”. The credit which is to be paid in one year or less called short
term financing.
Trade: Buying and selling of goods,
exchange of goods and services.
Credit: The payment in which deferment
period is involved. Credit means deferred payment sales.
Meaning Of Trade Credit: When buyer buys goods from seller on
credit in ordinary course of business. When seller sells the goods on credit
basis then he receives receivable and when buyer buys goods on the credit basis
he pays payable.
Weston Define It As: “Trade credit refers to the credit
that sellers grant to their customer during the ordinary course of business”.
Forms Of Trade Credit: There are three types of trade
credit which are as follow;
1)
Open Account
2)
Promissory Note
3)
Trade Acceptance
Now we can
discuss then in detail given below;
OPEN ACCOUNT: The credit arrangement in which the
seller just after evaluation credit worthiness, ship the goods to buyer along
with an invoice that specifies the goods shipped, the price, the total amount
due and the terms of credit. In open account trade credit will appear as
accounts payable on buyer’s book and account, receivable on seller’s book
because in this case there is verbal commitment between buyer’s and seller’s of
goods.
Features Of Open Account:-
1) There is no formal acknowledgment of
debts.
2) In this arrangement buyer does not
sign any legal document of any type.
3) It appears as account receivable on
seller’s book
4) It appears as account payable on
buyers book.
Procedure Of Arrangement Of Credit
Through Open Account:
First of all to avail credit through open account, the buying firm sends
purchase order to supplier. The supplier evaluate the credit worthiness of
buying firm on the basis of its character and past history etc. and if credit
worthiness is good then selling firm/supplier approves the credit and ships the
goods along with the copy of invoice price.
PROMISSORY NOTE: It is formal (unconditional) written
promise between buyer and seller. Where buyer make written promise to pay the
specified amount on specified date to the seller.
Features Of Promissory Note: Following are the some features of
promissory note as under;
1) In this case there is a formal
acknowledgment of debts.
2) Under this arrangement buyer sign the
note to make payment.
3) It is unconditional, because the
written promise is not backed by any assets.
4) It appears as trade note payable on
buyer book and note receivable on seller’s book.
5) It is used when;
a) The customer is new one.
b) Bulk of purchases involved.
c) Items are expensive.
d) Seller is unsure about the ability of
the customer to make payment.
Procedure Of Promissory Note: Under this arrangement, the buyer
place a purchase order to seller, then seller evaluate the credit worthiness of
buying firm/buyer. When seller in satisfied with the credit worthiness. Then
seller signs note and send it to the buyer along with ships goods and invoice
before taking possession of goods the buying firm also sign the note.
TRADE ACCEPTANCE: It is a formal acknowledgment of
debts that is initiated by seller of goods and accepted by the buyer of goods
in order to permit shipment of the desire goods.
Procedure Of Trade Acceptance: In two method of trade credit
following steps are involved;
1) Buyer request to the selling for the
purchase of goods to sending purchase order.
2) After evaluating the credit
worthiness of the buyer, selling will ship goods to the buyer.
3) Then seller will draw a draft in the
name of buyer and send draft along with bill of lading to the buyer.
4) In order to release the goods buyer
has to obtain bill of lading. In order to obtain bill of lading he has to
accept draft.
5) When he accept the draft he has to
sign on the back of draft and designate the name of bank through which payment
will be made.
6) Then draft which is now accepted will
be send back to the seller.
Advantages Of Trade Credit: The main advantages of trade credit
are as follows;
a)
Availability
b)
Flexibility
c)
Most Desirable
d)
No Restrictions
e)
Most Suitable For Small Firms
f)
Advantageous To Seller
Now we
discuss these advantages one by one given as under;
a) Availability:
The major advantage of trade credit is its ready availability. Because it is
appear as accounts payable in accounts and there is no need to financing
formality because it is already exists in books.
b) Flexibility:
It is more flexible mean of financing because firm does not have it pledge any
asset as a collateral. Just the supplier evaluates the credit worthiness of the
buyer.
c) Most Desirable:
When the buying firm’s take available cash discourtesy. The use as trade credit
adds nothing to the its cost. Therefore it is very desirable form of credit.
d) No Restrictions: In other types of short term financing borrowers negotiate with louder
and louder impose many restrictions in order to his position safe. But there is
no restrictions in case of trade credit.
e) Most Suitable For Small Firms: It is most suitable for small firms that have difficulty to
obtain credit or cannot obtain at all, but they have access trade credit.
Because of previous experience with sellers.
f) Advantageous To Sellers: It is also advantageous to seller because it represent a
virtual subsidiary by giving offering attractive terms of credit.
TERM OF SALES/CREDIT TERMS:-
Credit Terms: The conditions which are given by
the seller of goods extends to the buyer of
goods for the payment of debts in future dates. Seller sales goods to
the buyer on credit basis. The conditions under which the deferred payment
period is extended by the seller to the buyer.
Components Of Credit: Following are the components of
credit;
1) Cash Discount:
A percentage (%age) deduction in invoice price in order to induce the customer
for prompt payment.
2) Cash Discount Period: The number of days given by seller from beginning of credit terms during
which buyer can avail cash discount.
3) Net Date/Due Date: The number of days on which seller expect full payment from buyer.
Determinants Of Credit Term: Determinants are the factors that
influence the credit terms. These are as under;
1) Nature Of Commodity: Credit terms are depends effected by the nature or characteristics of
commodities. If commodity in perishable then seller will allow shorter credit
period and if commodity is durable then seller will allow larger credit period.
2) Turn Over: Credit
terms are also effected by turn over, if turn over is high then seller will
allow shorter credit period and if turn over is low then seller will allow
longer credit period.
3) Competition:
When there are large number of competition in the market then seller will
offer, longer period of credit term and vice versa.
4) Financial Position Of Seller: If financial position of seller is strong then such seller
offered, longer credit terms and if the financial position of seller is weak
then he cannot offered longer credit term, the will offered shorter credit
term.
5) Financial Position Of Buyer: If the buyer is financially strong he is regular customer
and purchases goods in bulk/large scale their to buyer seller will offer
liberal/long credit term and vice versa.