Academic journal article International Journal of Business

The Relationship between Trade Credit and Loans: Evidence from Small Businesses in Japan

Academic journal article International Journal of Business

The Relationship between Trade Credit and Loans: Evidence from Small Businesses in Japan

Article excerpt

ABSTRACT

Much of the existing literature on the relationship between trade credit and loans focuses solely on how a reduction in loans affects the use of trade credit. In this paper, we additionally investigate if a reduction in trade credit is offset by an increase in loans. Using a unique firm-level dataset of small Japanese businesses, we find the following: (1) as the lending attitude of financial institutions worsens, firms significantly decrease their use of trade credit, and (2) a reduction in trade credit, due to a decline in sales, leads to a reduction in the amount of loans extended. Our results provide evidence that small firms in Japan view trade credit and loans as complementary debt instruments. The primary implication of these findings is that bank-dependent small businesses may find their financing severely constrained in the event of major adverse shocks to real or financial activity.

JEL Classification: E44, G15

Keywords: Trade credit; Bank loans; Financial frictions

I. INTRODUCTION

What are the sources of financing for small and medium-sized firms (SMEs)? In contrast to large firms, the financing options of SMEs are limited, as they generally do not have broad access to bond and equity markets. In addition to loans from financial institutions, particularly banks, SMEs also depend heavily on trade credit. During commercial transactions, goods and services are often purchased on credit. In this case, since liabilities such as accounts and bills payable accrue until settlement, the purchasing firm temporarily borrows the goods and services from the supplier. This type of financing is known as trade credit because it is an extension of credit by a trading partner, not by a financial institution.

Trade credit plays a key role in firms' short-term financing and accounts for a considerable portion of a firm's liabilities. For instance, in Japan at the end of fiscal year 2002, the trade payables (total of accounts and bills payable) and trade receivables (total of accounts and bills receivable) share of total assets for non-financial corporations stood at 13.7% and 16.6%, respectively. The corresponding ratio of short-term (financial institution) loans to total assets was 15.7%. (1,2) Understanding the relationship between trade credit and loans, therefore, is crucial to not only understanding the short-term financing decisions of SMEs, but also to understanding how changes in financing impact the real activity of these firms.

Previous empirical investigations of the trade credit-loan relationship have primarily examined whether trade credit dampens or amplifies shocks to financial institutions. For instance, in a seminal paper, Meltzer (1960) focuses on periods of tight money and shows that companies with ample cash flow extend trade credit to firms that have been adversely affected by the reduction in bank lending. These studies, however, simply look at one "direction" of the relationship between trade credit and loans--that is, the implication of shocks to loans on the use of trade credit. For a more thorough understanding of the relationship, one must consider not only how disturbances to loans affect firm use of trade credit, but also how disturbances to trade credit affect the use of loans. For instance, firms facing financial difficulties due to a drop in trade credit often seek assistance from their main banks. At the same time, as much of the literature discusses, companies that are denied loans from banks are often able to survive because of "eased" access to trade credit, for example, an extension of a bills' settlement date. In this paper, we examine the differing impact of shocks to bank loans and shocks to trade credit on the short-term financing mix of Japanese SMEs in an effort to determine whether trade credit and loans are substitutes or complements

The exact nature of the relationship between these instruments is particularly relevant for the Japanese economy. …

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