5 Questions
Explain what trade credit is and how it is used as a source of financing for firms.
Trade credit refers to the credit that a customer gets from suppliers of goods, allowing them to defer immediate cash payments for purchases. It is a major source of short-term financing for firms, granted on an open account basis.
What is the difference between trade credit as an informal arrangement and trade credit in the form of bills payable?
Trade credit as an informal arrangement does not involve the formal acknowledgment of debt or legal instruments, while trade credit in the form of bills payable involves the buyer signing a bill, which appears on the buyer's balance sheet as bills payable.
How does trade credit contribute to establishing mutual confidence between the buyer and the seller?
Trade credit becomes a routine activity once the trade links are established, creating mutual confidence between the buyer and the seller. This confidence allows for the deferral of payments and periodic review of the trade credit by the supplier.
Under what circumstances might a supplier prefer to use bills payable for trade credit instead of an informal arrangement?
A supplier might prefer bills payable when they are less sure about the buyer's willingness and ability to pay, or when they want cash by discounting the bill from a bank.
What is the significance of a bill as a formal acknowledgement of an obligation in the context of trade credit?
A bill serves as a formal acknowledgement of an obligation to repay the outstanding amount, providing clarity and legal weight to the trade credit arrangement.
Test your knowledge of trade credit with this quiz! Explore the concept of trade credit, its importance as a source of financing for firms, and its role in the normal course of business transactions. Assess your understanding of this short-term financing arrangement and its impact on cash flow management.
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