Trade Credit

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Definition: Trade Credit

Firms generally make purchases from other firms on credit, recording the debt as accounts payable or trade credit.

Trade credit is the largest single category of operating current liabilities, representing about 40% of the current liabilities of the average nonfinancial corporation. Trade credit is a spontaneous source of financing in the sense that it arises from ordinary business transactions.

For example a firm makes an average purchase of Rs. 2,000 a day on terms of net 30, then it means that it pays for goods 30 days after invoice date. On an average it will owe 30 times 2,000 or Rs. 60,000 to its suppliers. If the sales and consequently, its purchases were to double, then its trade credit would also double to Rs. 120,000. So simply by growing, the firm can generate an additional amount of Rs. 60,000 of financing.

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