Trade Credit and Other Short-Term Sources

Alongside long-term and medium-term sources, every business also needs short-term finance to meet its ordinary working capital needs, and this AP Intermediate Commerce chapter identifies trade credit as the most common short-term source used by firms of every size.

Trade credit is the credit extended by a supplier to a business buying goods or raw material from it, allowing the buyer to pay for the purchase after an agreed interval — commonly thirty, sixty or ninety days — instead of paying cash immediately. It is, in effect, an interest-free (or very low-cost) loan of goods from the supplier, and its extent depends on the buyer's reputation, its past payment record, the volume of business between the two firms, and the general trade practice in that particular line of business. Trade credit is widely used because it is easy to obtain without any formal agreement or security, expands automatically as a firm's purchases grow, and involves no explicit interest cost as long as payment is made within the agreed credit period; a buyer who fails to pay on time, however, may lose the discount offered for prompt payment, damage its reputation with the supplier, and find it harder to get credit on the same easy terms in future.

Other short-term sources commonly listed alongside trade credit include a bank overdraft, under which a current-account holder is permitted to withdraw more than the balance in the account up to an agreed limit and pay interest only on the amount actually overdrawn, and cash credit, under which a bank sanctions a running credit limit against the security of stock or other assets, from which the borrower can draw funds as needed up to the sanctioned limit. Short-duration public deposits and short-term loans from banks, discussed for periods of less than a year, and bills discounting, where a business gets immediate cash from a bank against a bill of exchange it holds, in exchange for a small discount, are also grouped under short-term finance in a complete answer on this topic. …