Managing Trade Credit to Sustain Competitive Advantage. “Any firm committing around one fifth of its assets to accounts receivable needs to give serious attention to why it is doing so and whether it is adding value to the business.” (R Pike, N Cheng and L Chadwick)
“Credit is seen as part of a total
package, so as to enhance our position in winning business.
It is …. a competitive weapon.”
“We consistently look for new innovation
to improve our credit performance”
“We should ask
ourselves the following questions:
do firms offer trade credit?
can trade credit policies be developed to create a competitive advantage?
A clear understanding of the rationale for granting credit to customers, as
evidenced by a coherent and carefully devised credit policy, is an
important strategic consideration. Any
firm committing around one fifth of its assets to accounts receivable needs to
give serious attention to why it is doing so and whether it is adding value to
AID MARKETING AND PRICING DECISIONS
Trade Credit should be regarded as a promotional tool, not purely a financial
tool. Trade credit provision is an
important supplier selection criterion, especially when suppliers offer an
identical mix of variables such as price, quality and delivery.
Customers will purchase more from suppliers if more generous credit terms
are offered. Flexible payment terms
can also be arranged to support customer needs.
The use of price discrimination (a selectively relaxed collection
process) and/or inclusion of prompt payment discounts within the firm’s
pricing policy could be valuable tools.
2. TO MAKE WEALTH-CREATING INVESTMENTS IN ACCOUNTS RECEIVABLE
Accounts receivable should be regarded as an investment rather than the
passive consequence of sales. Financial
theory argues that firms should invest in trade credit if the net present value
of the revenue receivable ‘with credit being offered’ is greater than the
net present value arising ‘without credit’.
The trade credit decision can also be viewed from a longer-term perspective, looking beyond the accounts receivable figure on the balance sheet. Offering trade credit on “open account” provides a signal to the buyer that the seller is seeking to enter into a continuing relationship with the buyer. It is common practice within many firms to demand cash with order, or on delivery, and to subsequently go through credit screening procedures prior to granting credit. A powerful signal is therefore given to the customer through the granting of credit - namely that the supplier seeks a mutually beneficial long-term trading relationship.
3. TO EXPLOIT FINANCING
For most customers the high transaction costs involved in raising money, from
a bank for example, make trade credit a preferable financing arrangement - even
more so where the supplier has access to financial markets at rates that are not
available to its customers.
ACQUIRE/OFFER VALUABLE INFORMATION
Offering credit to customers generates valuable information for firms.
Offering two-part payment terms, involving prompt payment incentives, can be
used as a screening device to identify the default risk of prospective buyers.
Those refusing to take generous discounts are likely to be experiencing
cash-flow problems and will therefore require close monitoring.
Providing trade credit presents an opportunity to enhance corporate image,
build goodwill and promote customer loyalty. Trade credit can also be
interpreted as an implicit warranty, guaranteeing product quality.
CREATE COST AND OPERATING EFFICIENCIES
The separation of the exchange of goods from the exchange of money by the
seller offering a period of credit, creates a number of operating efficiencies
and cost improvements. Payment on
delivery is an inefficient practice in both supply chain management and reducing
payment transaction costs.
A survey of UK companies revealed the following as being the most common
trade credit motives :
Editor: Ron Wells