Advantages & Disadvantages of Trade Credit

One of the sources of short-term financing is business loans. Business loans arise as a result of buying and selling goods on credit. Short-term loans are very important to a firm. The definitions given by different thinkers about business loans are explained below:

According to I.M. Pandey, "Business credit refers to a type of credit that a buyer acquires from a seller in the normal course of business."


According to Benton Gup, "Trade credit refers to the creditor that is created due to the purchase of goods or services."

As a source of short-term financing, business loans, although not providing cash, have some unique features. The features of business loans are discussed below:

1. Remaining purchases: In the rest, business loans are created through purchases. Every businessman needs to make a product or service. In most cases, the buyer does not have to pay the price immediately after purchasing the product or service. The seller fixes a certain time for payment of his dues. This is called a business loan.

2. Term of loan: All buyers have different transactional behavior. As a result, the loan tenure is also different for everyone. However, business loans are provided for an average of 7-90 days. There is also a fixed time limit for receiving the cash allowance.

3. Cycle: Business loans are repaid over a fixed period i.e. 1 week, 2 weeks, 1 month, or 2 months. Re-purchase the remaining balance and it is paid. Thus the process of creation and repayment of this debt continues cyclically.

4. Collateral: The buyer's integrity, reputation, and buyer-seller relationship act as collateral for business loans. Business loans only involve a close relationship between the buyer and the seller. Product purchases and remaining payments are cycled. So no collateral is required.

5. Flexibility: Business loan amounts fluctuate at any time. There is no upper or lower limit set by the seller. The buyer determines the amount of the business loan according to his needs.

The biggest source of short-term loans is business loan cash back. At present, one cannot gain a favorable position in business without outstanding transactions. Due transactions result in business debt. The benefits of business loans are discussed below:

1. Availability: Business loans are readily available and can be collected within a short period. Any business can collect this loan with less hassle.

2. Informality: Due to informality, product buyers can easily collect such loans. Buyers can borrow from such businesses by placing orders through mail or telephone. No formality is required.

3. Business Existence: Various business organizations grant business loans to sustain their existence and reputation. No business can survive in competition if it sells products on a cash basis.

4. Cost affordability: Business loans have little or no cost of capital. This loan has no capital cost if the seller puts the purchase price at the cash price of the goods sold. However, the seller charges a slightly higher price for the rest of the sale. But interest is lower than other loans.

5. Collateralless: Business loans do not require any collateral. Reputation and good buyer-seller relationships etc act as business collateral. But in the case of a financially weak and new buyer, the seller can demand a third-party guarantee.

Along with the advantages of business loans, there are also some disadvantages for both the buyer and the seller. It is discussed below:

1. Repayment in a short time: Business loans are given very short time i.e. 1-3 months. Many times it may not be possible to repay the loan in time. As a result, there is a risk of deterioration in the relationship between the buyer and the seller and subsequent closure of the transaction.

2. Frequent pressure on liquidity: As the repayment period of business loans is short, the purchase price repayment cycle needs to continue. Otherwise, the loan facility may be canceled or suspended. This puts more pressure on business liquidity and causes liquidity crises.

3. Tax Disadvantages: Interest on any loan is shown as profit and loss in the company as it is a cost to the business entity. This results in lower business profits and less tax to be paid. But the cost of business loans is not shown as profit and loss in the company.

4. High opportunity cost of credit: In most cases, the buyer forgoes the interest rate and repays the business loan over the maximum term. The loss of interest rate increases the opportunity cost of borrowing substantially.

5. Chances of credit are high: If you sell on credit, there is a possibility of not getting a part of the total price, that is, there is a chance of bad credit. Many times the borrower defaults and in some cases intentionally defaults. As a result, a large portion of the total debt becomes uncollectible.