Explain trade credit and bank credit as sources of short-term finance for business enterprises.
Trade credit: It refers to the credit extended by the supplier to the purchaser of goods or services. It promotes the purchase of goods and services as the purchaser need not make immediate cash payments if trade credit is extended. Trade credits are granted only to customers or traders who are considered to be creditworthy by the supplier.
Merits of trade credit as a source of short-term finance:
(a) Trade credit helps a company to finance the accumulation of inventories for meeting future increase in sales.
(b) As the trade creditors do not have any rights over the assets of the company, it can mortgage its assets to raise money from other sources.
Demerits of trade credit as a source of short-term finance:
(a) Easy availability of trade credit can result in overtrading, which in turn increases the future liabilities of the buyer.
(b) The amount of funds that can be generated through trade credit is limited to the financial capacity of the supplier or the creditor.
Bank credit: Bank credit is a loan advanced by a bank to a business firm. The interest charged by the bank on the loan usually depends on the interest rate prevailing in the economy. The borrower needs to mortgage assets with the bank to secure the loan.
Merits of bank credit as a source of short-term finance:
(a) Banks maintain secrecy over information related to their customers.
(b) Bank credit provides flexibility to the borrower as the borrower can increase or decrease the amount of loan according to the business needs.
Demerits of bank credit as a source of short-term finance:
(a) It is difficult to increase the loan.
(b) The terms imposed by banks are often very restrictive—for example, the bank that has granted a loan may restrict the sale of goods mortgaged to it by the borrower.