Trade Credit Definition
Trade credit refers to postponing payment for goods or services received. It is buying goods on credit, or extending credit to customers. It is also receiving goods now and paying for them later. And trade credit is delivering goods to a customer now and agreeing to receive payment for those goods at a later date. Trade credit terms often require payment within one month of the invoice date, but may also be for longer periods. Most of the commercial transactions between businesses involve trade credit. This type of credit facilitates business to business transactions and is a vital component of any commercial industry.
If a consumer receives goods now and agrees to pay for them later, the goods were purchased with trade credit. Likewise, if a supplier delivers goods now and agrees to receive payment later, the sale was made with trade credit. There are two types of trade credit: trade receivables and trade payables. Trade credit payables and receivables can become complex and it is important to manage trade credit properly and accurately.
Accounting Trade Credit
For accounting purposes, the value of goods bought on credit is recorded on the balance sheet in an account called accounts payable, representing money the company owes for goods it already received. These are trade payables.
While the value of goods sold on credit is recorded on the balance sheet in an account called accounts receivable, representing the money owed to a company for goods it already delivered to customers. These are trade receivables.
Trade credit is essentially a short-term indirect loan. When a supplier delivers goods to a buyer and agrees to accept payment later, the supplier is essentially financing the purchase for the buyer. Trade credit is an interest-free loan. As long as the buyer postpones payment, the buyer is saving the money that would have been spent on interest to finance the purchase with a loan. At the same time, the supplier is losing the interest it would have earned had it received the payment and invested the cash. Therefore, the buyer wants to postpone payment as long as possible and the supplier wants to collect payment as soon as possible. That is why suppliers often offer discount credit terms to buyers who pay sooner rather than later.
Trade Receivables Definition
Trade receivables represent the money owed but not yet paid to a company for goods or services already delivered or provided to the customer. The goods were delivered and the sale was recorded. But the cash was not yet received. Record trade receivables as an asset on the balance sheet in an account called accounts receivable.
Trade Payables Definition
Trade payables represent the money a company owes but has not yet paid for goods or services that have already been delivered or provided from a supplier. The goods were received, the expense was recorded, but the cash was not yet paid. Trade payables are recorded as a liability on the balance sheet in an account called accounts payable.