Magazine article The Small Business Advocate

Advocacy Study Examines Small Business Credit Structure, Highlights Widespread Use of Trade Credit

Magazine article The Small Business Advocate

Advocacy Study Examines Small Business Credit Structure, Highlights Widespread Use of Trade Credit

Article excerpt

The Office of Advocacy has just released a new study examining small businesses' use of credit and the use of bank credit (loans) and supplier credit (trade credit). While there is a wide and growing literature on bank credit, trade credit has received less attention. As the new study documents, trade credit is almost as pervasive as bank credit in both incidence and volume. In this time of tightened credit, small businesses are looking not only to financial institutions, but also to their suppliers, as sources of funds. While policymakers have focused on how to get banks to increase lending to small firms, they should also address the equally important trade credit channel of funding.

In conducting their normal operations, businesses of all sizes extend credit to one another in the form of "accounts receivable." For instance, a firm might submit an invoice with the "terms of trade" being "2/10 net 30." This means that a 2 percent discount is given for payments made within 10 days or the full amount is due in 30 days. This practice is referred to as "trade credit" - an instrumental tool for business financing. Bank Credit, Trade Credit or No Credit: Evidence from the Surveys of Small Business Finances, by Rebel A. Cole of Krähenbuhl Global Consulting, finds that three out of five small firms use trade credit. The pervasive use of trade credit shows that it is an important, albeit specialized, form of financing for small businesses.

The fact that trade credit typically is more expensive than other forms of credit undoubtedly influences its use. In the example cited earlier (2/10 net 30), the implied annual interest rate is 45.5 percent for firms that pay on the 30th day. Consequently, firms tend to use trade credit as a short-term finance tool. Its use reflects suppliers' interests in encouraging more sales, rewarding creditworthy customers, and adhering to common industry practices. …

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