See Also:
Fixed Charge Coverage Ratio Analysis
Bank Charge
Open Account
Accounting Controls
Hold Harmless
Credit Account
Charge Account Definition
A charge account, defined as an account in which a company can charge trade credit, is one of the most commonly used methods of financing around the world. Trade credit, when purchasing products from a vendor, is assigned to a charge account for the business buying products. This type of account is the same thing as a trade account.
Charge Account Explanation
Charge accounts explained by some business as their greatest fear or largest asset. For a company to afford the valuable capital investments required to operate it must use some form of financing. When the a company receives financing from the maker of the product, which is the capital investment, it is called trade credit.
In order to keep track of trade credit a company completes a charge account application. With this account, a company can charge purchases which are trade credit. These purchases, however, are only able to be made from the provider of the trade credit.
Associated with a charge account are terms, maximum and minimum balances, interest on the principal of the trade credit financing, and other loan terms. These are negotiated before the charge account is created. Terms are often very different depending on the needs of both parties involved.
When comparing charge account vs credit card think deeply: will my vendor provide better terms? Will they have less requirements? Will they require any collateral? Perform a simple calculation to find which is the most logical financial decision.
Example
Lou owns a shoe making company. Both machines and man make Lou’s products. It is the combination of these two elements which provides efficient processing of quality products. Lou works diligently to assure this.
Lou needs a new machine to aid his workers. This piece of equipment, a heavy-duty sewing machine, will increase his company productivity per labor hour.
The problem is that Lou’s money is tied up in the day-to-day operations of his business. Lou does not have the cash to save his company money!
Luckily, Lou finds out that the maker of this new machine offers trade credit. This line of credit allows Lou to receive the item and begin more efficient work. He will pay the item off within the terms of the loan.
Lou creates a charge account with his vendor. This allows him to regularly charge items to his account: other equipment, tools and parts for the machine, and other necessities. He can charge to the account, if he is willing to pay interest, and send payment later than purchasing with cash. He will include a charge account for proper processing of purchase orders.
Lou appreciates his new freedom. He knows a company can get itself into trouble with a charge account. Still, when monitored and used effectively the company can better itself with prudent use of this tool.
