Question

Logica utilises contractors to install its software to end users. To facilitate the provision of these goods, the company provides a standard trade finance facility to these contractors.

a) Explain how trade credit operates and how both Logica and the contractor would benefit from this type of facility.

Answer 1

a)

UNDERSTANDING OPERATION OF TRADE CREDIT-

A trade credit is an advantage for a buyer. In some cases, certain buyers may be able to negotiate longer trade credit repayment terms which provides an even greater advantage. Often, sellers will have specific criteria for qualifying for trade credit.

A B2B trade credit can help a business to obtain, manufacture, and sell goods before ever having to pay for them. This allows businesses to receive a revenue stream that can retroactively cover costs of goods sold. Walmart is one of the biggest utilizers of trade credit, seeking to pay retroactively for inventory sold in their stores. International business deals also involve trade credit terms. In general, if trade credit is offered to a buyer it typically always provides an advantage for a company’s cash flow.

Since trade credit puts suppliers at somewhat of a disadvantage, many suppliers use discounts when trade credits are involved to encourage early payments. A supplier may give a discount if a customer pays within a certain number of days before the due date. For example, a 2% discount if payment is received within 10 days of issuing a 30-day credit. This discount would be referred to as 2%/10 net 30 or simply just 2/10 net 30.

contractor would benefit from this type of facility in following ways-

1.Low-Cost Finance

Trade Credit is considered as the cheapest form of working capital finance. All other sources of working capital finance such as bank overdraft, cash credit, etc have interest cost attached to it Practically, there is no interest cost attached to trade credit provided the dues are paid within the credit period provided by the supplier/ creditor. (refer: Cost of Trade Credit)

2.Discounts on Early Payments

It is not only the free source of finance but also gets a discount if paid before a certain period of time. Credit terms say “2/10 net 30”. If paid on the 10^th day, the buyer will get a discount on the bill as well as the free credit period of 10 days.

3.Easily Maintainable

Accounting is an integral part of any business and managing trade credit does not require too many additional efforts apart from normal accounting and administering the time of payment which anyhow a business will do.

4.No Legal and Banking Botheration

Since there is no formal negotiable instrument being executed, trade credit is free from any legal repercussions. Also, since the banks are not involved anywhere, there is no fear of account going NPA – Non-Performing Asset.