As an important trading facility, trade credit gives an immense opportunity to buyers to purchase goods and services on credit terms. In financial illiquidity situations, firms use this service to derive their operations with delayed payments.
In business, trade credit is a financial provision which is provided by non-financial firms in the form of receivables. Demand for trade credit research has greatly been influenced by market developments in different parts of the world. During the financial crisis of 2007-2008, it dominantly substituted bank financing and became a viable source of finance.
Trade credit research before and during the global crisis period
Before global financial uncertainty, firms used to trade on a cash basis. With an occurrence of crisis, developing and even developed countries faced a drastic shortage of liquidity. The banking and financial system collapsed with losses and huge loss of assets. In the crisis period, trade credit played an important role in redistributing financial liquidity from financial institutions to trading firms. Financially constrained buying firms approached suppliers for purchase with delayed payments.
Following are some aspects regarding trade credit before global financial uncertainty:
- Use as a choice: Usually, production and trading firms would buy goods and services on an instant payment system. For this, they financed purchases with credit from financial institutions. Trade credit in the form of financial receivables became a trend later on.
- The financial advantage with trade financing: Suppliers with trade credit financing enjoyed an advantage over banks as they would collect customer information at a low cost. Even in case of default, they got more salvage value as compared to banks.
With the introduction of global unrest in every part of the world, trade financing has changed its role in the financial industry. According to the Redistribution theory of Meltzer, large firms have more access to the financial market for redistributing credit to small trading firms. With this, large firms played a dominant role in providing credit purchases to small firms.
Later on, large and small firms lost their financial credit position. They faced issues in getting loans and credit purchases and supplies.
Trade credit position after the financial crisis
The financial crisis has affected the trade credit position drastically. Meltzer’s redistribution hypothesis proved wrong due to the unavailability of finance in the banking sector. Major firms lost their credit accessibility with banks. Small firms faced huge problems in buying goods and services from large firms.
With the gradual development of the financial market after the crisis, the banking and lending sector has initiated credit services for firms that provide credit sales support to their customers.
Position in the present financial scenario
In the present scenario, companies are using credit purchase and sales services to improve business-to-business relationships. Companies enter into a business agreement to buy products with a term to make deferred payments with a specific maturity period. The firm decides the deferred payment period with mutual consideration to provide maximum benefits to both traders. With a systematic implementation of credit trade, firms derive maximum sales and profits. Along with credit sales providers, purchase companies maximize their profits with managed cash flows.
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