Explain the motives for the extension of the trade credit.

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Expert Solution

Rationale for extension of trade credit:

1. Financial motive: Firms usually sell on credit at higher prices than for cash. This helps generate greater profit while raising the capital at lower costs. Sellers usually have cost advantage over buyers.

2. Operating motive: Suppliers allow trade credit to help buyers meet the production requirements while adjusting its accounts receivable in case of demand fluctuations. This helps the manufacturing process insulated from deviations of demand.

3. Contracting cost motive: When trade credit is extended it allows the contract costs between sellers and buyers to reduce. The buyers can inspect the quality of goods prior to payment and reduce the money for any defective or missing goods. Also seperation of delivery and collection of cash activities helps the seller achieve gains due to specialization of labor. This helps the seller reduce instances of cash theft when cash is not collected at the time of delivery.

4. Pricing motive: Pricing for a seller depends on market conditions and in certain industries sellers are unable to alter market prices. In case credit is extended, it allows the seller to make unpublished variations to the policy.

jeff jeffy answered 1 year ago

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