The Scale Of Trade Credit

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Trade credit, as defined by (Paul and Boden, 2008) allows customers to delay payments for goods or services to a supplier for a specified period of time. Alternatively, Laffer (1970) defines trade credit as “a means through which money is transferred from economic entities possessing idle money balances to entities in need of additional money balances” (Laffer, 1970, pp. 242). Globally, the scale of trade credit is significant such that in most developed countries it exceeds short-term bank credit (Blasio, 2003) and is an important way of financing firms’ working capital (Peel and Wilson, 1996; Paul and Boden, 2008).
At least 30% of all credit-based sales in developed and emerging markets are paid outside the agreed terms, with fewer paid
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They did not, however, explain how their results relate to the theoretical literature on the financing motive for trade credit.
Summers and Wilson (1999), using data from 655 UK firms, investigated the theoretical motivations for the use of trade credit by firms for purchases. The demand for credit was modelled as a function of transaction costs motivations, financing motivations, operational considerations, seller compliance issues, supplier marketing, and environmental issues, while controlling for firm characteristics such as size and industry. The results suggest that trade credit is generally perceived as a cheap financing option, giving support for the financing motive. These findings for the UK environment seem to contrast with Elliehausen & Wolken (1993) who in their study of trade credit demand in the USA state that sellers that extend trade credit typically offer cash discounts to encourage early payment.

The most obvious reason as to why customers and indeed businesses use trade credit could be attributed to the transactional theory. In the absence of trade credit, firms must pay for purchases upon delivery. Seasonal businesses may demand extended credit terms due to their irregular cash flows and to achieve balance in their cash conversion cycle (Wilson and Summers, 2002; Paul, 2004). Ferris (1981) when testing the transaction and financing theories
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