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trade credit

finance
Written and fact-checked byThe Editors of Encyclopaedia Britannica
The Editors of Encyclopaedia Britannica
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trade credit, deferment of payment for goods or services purchased by one company from another, granted by the seller for a short period, primarily to give the buyer a means of financing inventories. This type of credit (known as open-book account credit), recorded by the seller as accounts receivable and by the buyer as accounts payable, is most prevalent in U.S. domestic trade. International trade and trade within many European countries is more often financed by means of trade acceptances and promissory notes.

The extent and pattern of trade credit within an industry depend on a number of factors, including the average rate of turnover of stock, the nature of the goods involved—e.g., their perishability—the relative sizes of the buying and selling firms, and the degree of competition. If inventories of goods turn over quickly, for example, it is likely that a large amount of very short-term credit will be extended. Longer-term credit will be extended for goods with slow rates of turnover. As would be expected, large companies are likely to be net lenders to smaller ones.

The cost of extending trade credit may be explicit in the terms of sale if they include a discount granted for immediate payment. An invoice for $500 due in 30 days, for example, may specify a discount of 2 percent or $10 if paid within 10 days (denoted as 2/10, net 30). Even in cases in which it is not so apparent, a cost for the use of funds until the due date is borne by the buyer, by the seller, or by both.

This article was most recently revised and updated by Jeannette L. Nolen.