There are mainly two types of trade credit and they are commercial credit and consumer credit.
Credit means deferred payment. In business cash sales are welcome but the volume of sales will not be very- big because customers do not always remain with cash.
Credit undoubtedly increases the volume of sales. There is a number of issues in connection with credit useful with reference to increasing the volume of sales.
These are discussed here: types of trade credit, decision to sell for cash or credit.
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Types of trade credit
There are two kinds of credit. Commercial credit is credit that an entrepreneur gives to other business consumer credit is credit that an entrepreneur extends to individual customers.
Commercial Credit
In retailing or services, entrepreneurs often can choose whether to sell for cash or credit. In wholesaling or manufacturing, they rarely have that choice, mostly because:
- Buyers want to scan the deliverer products before paying the seller.
- Buyers depend on the seller to deliver the product to locations far from the seller’s site.
- Buyers need to have the purchase financed by the seller.
Consumer Credit
Especially vulnerable to financial loss are entrepreneurs who sell directly to individual customers on credit. To screen these customers, entrepreneurs should first settle two vital questions:
- Does the customer have a history of paying bills promptly?
- How much ‘credit can the customer safely absorb?
The decision to Sell for Cash or Credit
Nearly all small businesses can sell on credit if they wish, and so the entrepreneur must decide whether to sell for cash or on credit. In some cases, this is reduced to the question, “Can granting of credit to customers be avoided?”
Credit selling is standard trade practice in many lines of business, and in other businesses, credit-selling competitors will always outsell the cash-selling firm.
It should be obvious that most manufacturers and wholesalers – one exception being the small group of cash-and-carry wholesalers – must extend credit to customers.
Even in retailing, the trend is toward more credit sales, so the pressure to extend credit to customers is increasing,
Factors That Affect the Decision
Numerous factors bear on the decision concerning credit extension. The seller always hopes to increase profits by credit sales, but each firm must also consider its own particular circumstances and environment.
Type of Business. Retailers of durable goods, for example, typically grant credit more freely than small grocers who sell perishables. Indeed, most consumers find it necessary to buy big-ticket items on an installment basis; the product’s life makes installment selling possible.
Availability of Adequate Working Capital: There is no denying the fact that credit sales increase the amount of working capital needed. Money that the business has tied up in open-credit and installment accounts cannot be used to pay business expenses
Credit Policy of Competitors: Unless a firm offers some compensating advantage, it is expected to be as generous as its competitors in extending credit. Wholesale companies and retail furniture stores are businesses that face stiff competition from credit sellers.
Income level of Customers. The income level of customers is a significant factor in determining a retailer’s credit policy. Consider, for example, a corner drugstore adjacent to a city high school; high school students are typically unsatisfactory credit customers because of their lack of maturity and income.
Four Credit Questions
In evaluating the credit standing of applicants, the entrepreneur must answer the following questions:
- Can the buyer pay as promised?
- If not, can the buyer be forced to pay?
- Will the buyer pay?
- If so, when will the buyer pay?
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