Trade Credit Advantages and Disadvantages and Steps in Granting Credit

Trade credit is the most important term in every kind of business. Here we discuss trade credit advantages and disadvantages.

Advantages of trade credit

  1. Credit customers are likely to become repeat customers.
  2. Credit enables customers to buy products or services they might otherwise have to do without.
  3. Credit customers tend to overspend
  4. Credit customers tend to buy products of higher quality.
  5. Credit is a convenience to customers who dislike carrying cash.
  6. Credit customers pay less attention to prices.
  7. Credit sales require less selling effort.

Disadvantages of trade credit

  1. Credit forces entrepreneurs to finance their customers, thus tying up money in accounts receivable.
  2. The privilege of returning products.
  3. Credit may obligate entrepreneurs to borrow and repay with interest
  4. Credit adds to the cost of doing business because of investigations and the book ­keeping needed to keep records, bill customers, and collect payments.
  5. Credit refusal may cause ill will.
  6. Credit customers are more likely to abuse

Hope this trade credit advantages and disadvantages clear your concept about trade credit. Below we mention steps in granting credit.

Steps in Granting Credit

1. Collect customer basic information

Have the applicant for consumer credit fill out a credit application that calls for such basic information as name, address, age, present, and past employment, length of employment, salary, home ownership details, past credit extended, payments now being made on other accounts, bank accounts, family status including dependents, and other asset information. Applicants for trade credit should submit their companies’ official statements.

2. Check customer information

Check the applicant’s credit record with the local credit bureau and other credit agencies. Find out what limits were placed on the applicant’s credit by other firms.

Remember, you are always looking for evidence of the applicant’s possession of the “five C’s of credit” –

  1. Character,
  2. Capital,
  3. Collateral,
  4. Capacity, and
  5. Conditions.

Trade-credit applicants are checked by credit bureaus and/or by Dun & Bradstreet, a general trade-credit agency.

3. Decide credit limit

Based on independent investigation plus confirmation of information or the application, determine the limit of credit you feel can safely be granted.

If the applicant is a high risk, the decision must be to deny any credit at all. If the applicant is worthy of credit, compare the amount of the desired merchandise purchase with the limit you have set.

Trade credit advantages and disadvantages

This will determine whether the applicant should be granted credit on an installment-loan basis, a revolving-account basis, a budget-account basis, or an open account.

4. Discuss the decision with applicants

Discuss your decision with all applicants. Explain the reasons for the decision if asked.

Support your decision by explaining that applicants’ payments must be in line with their available income. If credit is denied, explain that you are protecting them from getting too far into debt.

5. Follow-up on the new credit accounts regularly

This can be done even before the aging of accounts receivable (to be explained later in this chapter) is made.

When payments are delinquent and notices and other steps taken have been ignored, it may be necessary to exercise the right of repossession if it is available.

If all has worked out well, it is desirable to inform the customer that, better credit terms can be arranged in the future.

6. Avoid discrimination

Avoid any form of discrimination as to race, sex, age, color, religion, or minority status in processing applications for credit.

Controlling Credit Costs

If a business firm extends credit to customers, increased expenses are almost inevitable. The following direct costs are related to credit sales:

  1. Credit investigations
  2. Collection costs
  3. Bad debts
  4. Book-keeping and billing costs; and
  5. Cost of funds tied up in accounts receivable;

Increased bookkeeping expenses are usually the greatest of these, but each adds something to the total expenses of any firm with a substantial credit business.

Aggressive efforts are made to ensure timely payments for credit sales. Selective credit sanctions and regular follow-up will surely improve collections and minimize bad debts. Thus, credit costs can be managed to a reasonable level.

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