Trade credit allows businesses to purchase goods or services without immediate payment, instead billing later within an agreed upon timeframe, usually 30-60 days. It is a major source of working capital for many businesses. For example, Walmart uses trade credit as a larger source of capital than bank loans. Deferred income is income received but not yet earned, as the goods or services have not been provided yet. Accrued expenses are expenses that have occurred but are not yet recorded, so an adjusting entry must be made to properly account for them. Commercial paper is an unsecured short-term loan issued by large corporations or banks to meet short-term debts, maturing within 1-270 days. It must be rated by a credit

1. 1. Trade credit
It is an arrangement between businesses to buy goods or services on account,
that is, without making immediate cash payment. The supplier typically provides
the customer with an agreement to bill them later, stipulating a fixed number of
days or other date by which the customer should pay. It can be viewed as an
essential element of capitalization in an operating business because it can
reduce the required capital investment required to operate the business if it
is managed properly. Trade credit is the largest use of capital for a majority of
business to business (B2B) sellers in the United States and is a critical source of
capital for a majority of all businesses. For example, Wal-Mart, the largest retailer
in the world, has used trade credit as a larger source of capital than bank
borrowings; trade credit for Wal-Mart is 8 times the amount of capital invested by
shareholders.
Example
The operator of an ice cream stand may sign a franchising agreement, under
which the distributor agrees to provide ice cream stock under the terms “Net 60”
with a ten percent discount on payment within 30 days, and a 20% discount on
payment within 10 days. This means that the operator has 60 days to pay the
invoice in full. If sales are good within the first week, the operator may be able to
send a cheque for all or part of the invoice, and make an extra 20% on the ice
cream sold. However, if sales are slow, leading to a month of low cash flow, then
the operator may decide to pay within 30 days, obtaining a 10% discount, or use
the money another 30 days and pay the full invoice amount within 60 days.
The ice cream distributor can do the same thing. Receiving trade credit
from milk and sugar suppliers on terms of Net 30, 2% discount if paid within ten
days, means they are apparently taking a loss or disadvantageous position in this
web of trade credit balances. Why would they do this? First, they have a
substantial markup on the ingredients and other costs of production of the ice
cream they sell to the operator. There are many reasons and ways to manage
trade credit terms for the benefit of a business. The ice cream distributor may be
well-capitalized either from the owners’ investment or from accumulated profits,
and may be looking to expand his markets. They may be aggressive in
attempting to locate new customers or to help them get established. It is not on
their interests for customers to go out of business from cash flow instabilities, so
their financial terms aim to accomplish two things:
Allow startup ice cream parlors the ability to mismanage their investment
in inventory for a while, while learning their markets, without having a dramatic
negative balance in their bank account which could put them out of business.
This is in effect, a short term business loan made to help expand the distributor’s
market and customer base.
By tracking who pays, and when, the distributor can see potential problems
developing and take steps to reduce or increase the allowed amount of trade
credit he extends to prospering or faltering businesses. This limits the exposure
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2. to losses from customers going bankrupt who would never pay for the ice cream
delivered.
Advantages of Trade credit
Reduced capital requirements, this means that if a new business setting up has
trade credit, they will obviously require less money in capital to start up the
business. This is a major advantage to someone who has very little money but
has a good idea about starting a new business.
Trade credit with improve the cash flows and therefore provide smoother
operation for the business
Businesses can buy now and pay later which means even if they don’t have the
money at first they can purchase items, sell them as a business and then make
the payments at the end of the month when the products have been sold and a
profit has been made.
Businesses can look to grow without having to worry of needing to make
immediate payments which may set them back.
With trade credit, the business can focus on other areas such as sales,
marketing and research rather than worrying about meeting targets just to have
enough money to pay the bills.
Disadvantages of Trade credit
If repayments are not made by certain deadlines, the business will receive a poor
credit history which will be a big blow to any business as they will not trusted in
the future if they require any loans, trade credit, credit cards or leasing.
Only companies with a good credit history will get trade credit and these can
often be hard to build up, especially for new businesses
2. Deferred income
It is income received during an accounting period, but for which the company has
not yet supplied the goods and services as at the end of the period, so which
cannot be recognised as income. These amounts should not be included in
the P & L for the period.
An item that gives rise to deferred income is the other side of a prepayment.
Where a buyer has a prepayment, its supplier will have deferred income.
For example, a company receives an annual software license fee paid out by a
customer upfront on January 1. However the company's fiscal year ends on May
31. So, the company using accrual accounting adds only five months worth
(5/12) of the fee to its revenues in profit and loss for the fiscal year the fee was
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3. received. The rest is added to deferred income (liability) on the balance sheet for
that year.
3. Accrued Expenses
Accrued expenses are expenses that have occurred but are not yet recorded
through the normal processing of transactions. Since these expenses are not yet
in the accountant’s general ledger, they will not appear on the financial
statements unless an adjusting entry is entered prior to the preparation of the
financial statements.
For example A company borrowed $200,000 on December 1. The agreement
requires that the $200,000 be repaid on February 28 along with $6,000 of interest
for the three months of December through February. As of December 31 the
company will not have an invoice or payment for the interest that the company is
incurring. (The reason is that all of the interest will be due on February 28.)
Without an adjusting entry to accrue the interest expense that the company has
incurred in December, the company’s financial statements as of December 31
will not be reporting the $2,000 of interest (one-third of the $6,000) that the
company has incurred in December. In order for the financial statements to be
correct on the accrual basis of accounting, the accountant needs to record an
adjusting entry dated as of December 31. The adjusting entry will consist of a
debit of $2,000 to Interest Expense (an income statement account) and a credit
of $2,000 to Interest Payable (a balance sheet account).
4. Commercial paper
It is an unsecured promissory note with a fixed maturity of 1 to 270 days.
Commercial Paper is a money-market security issued (sold) by
large banks and corporations to get money to meet short term debt obligations
(for example, payroll), and is only backed by an issuing bank or corporation's
promise to pay the face amount on the maturity date specified on the note. Since
it is not backed by collateral, only firms with excellent credit ratings from a
recognized rating agency will be able to sell their commercial paper at a
reasonable price. Commercial paper is usually sold at a discount from face value,
and carries higher interest repayment rates than bonds. Typically, the longer the
maturity on a note, the higher the interest rate the issuing institution must pay.
Interest rates fluctuate with market conditions, but are typically lower than banks'
rates.
Who can issue?
Corporates and primary dealers (PDs), and the all-India financial institutions (FIs)
that have been permitted to raise short-term resources under the umbrella limit
fixed by Reserve Bank of India are eligible to issue CP. A corporate would be
eligible to issue CP provided: (a) the tangible net worth of the company, as per
the latest audited balance sheet, is not less than Rs. 4 crore; (b) company has
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4. been sanctioned working capital limit by bank/s or all-India financial institution/s;
and (c) the borrowal account of the company is classified as a Standard Asset by
the financing bank/s/ institution/s.
Rating Requirement
All eligible participants shall obtain the credit rating for issuance of Commercial
Paper from either the Credit Rating Information Services of India Ltd. (CRISIL) or
the Investment Information and Credit Rating Agency of India Ltd. (ICRA) or the
Credit Analysis and Research Ltd. (CARE) or the FITCH Ratings India Pvt. Ltd.
or such other credit rating agencies as may be specified by the Reserve Bank of
India from time to time, for the purpose. The minimum credit rating shall be P-2 of
CRISIL or such equivalent rating by other agencies.
Maturity
CP can be issued for maturities between a minimum of 7 days and a maximum
up to one year from the date of issue.
Denominations
CP can be issued in denominations of Rs.5 lakh or multiples thereof. Amount
invested by a single investor should not be less than Rs.5 lakh (face value).
Limits and the Amount of Issue of CP
CP can be issued as a "stand alone" product. The aggregate amount of CP from
an issuer shall be within the limit as approved by its Board of Directors or the
quantum indicated by the Credit Rating Agency for the specified rating,
whichever is lower. Banks and FIs will, however, have the flexibility to fix working
capital limits duly taking into account the resource pattern of companies'
financing including CPs. An FI can issue CP within the overall umbrella limit fixed
by the RBI i.e., issue of CP together with other instruments viz., term money
borrowings, term deposits, certificates of deposit and inter-corporate deposits
should not exceed 100 per cent of its net owned funds, as per the latest audited
balance sheet.
Every issue of CP, including renewal, should be treated as a fresh issue.
5. International money market
The international money market is the market that handles the international
currency transactions between the various central banks of the nations. In the
international money market, the transactions are carried out mainly in gold or in
US dollar.
International money market is governed by the international monetary
transactions between various nations currency. The international money market
mainly handles the currency trading between the countries. The trading of one
country's currency for another one is also named as the foreign exchange
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5. currency trading or forex trading. The international money market has grown
phenomenally over last few years and is expected to grow even more. It is the
largest financial market in the world and the participants in this large market are
large banks, central banks, governments, multinational corporations and
currency speculators.
A money market is the safest financial market available and is commonly used by
the big financial institutions, large corporations and governments. The investment
made in a money market is generally for a very short period of time and hence
they are often referred as cash investments. The basic performance of the
international money market involves the money borrowing or lending by a
government or some large financial institutions. Unlike share markets, the
international money market deals with much larger fund and the players of the
market are big financial institutes. The international money market allows
investing in a less risk while the return that comes from that is also less. The best
way to invest in the international money market is by money market mutual funds
or treasury bills.
Everyday the international money market regulates a huge amount of
international currency trading. According to the reports given by the Bank for
International Settlements, the daily turnover in a traditional exchange market
estimated is $1880 billion.
The major international money market participants are:
Citigroup
Deutsche Bank
HSBC
Barclays Capital
UBS AG
Royal Bank of Scotland
Bank of America
Goldman Sachs
Merrill Lynch
JP Morgan Chase
The international money market takes care of the exchange rates on a regular
basis. Currency band, exchange rate regime, fixed exchange rate, linked
exchange rate and floating exchange rates are some of the other indices that
govern the international money market in a huge way.
6. Long term vs Short term Debt
Operating a business oftentimes requires obtaining different types of
financing. Businesses obtain loans for everything from capital investments to
resolving temporary revenue shortfalls. The types of loans used by businesses
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6. include short-term and long-term debts as well as debits of both of these types
that are secured or unsecured.
Types
Two basic types of financing available for businesses are long-term and short-
term debt. Long-term debt is defined as financial obligations that extend beyond
one year. Short-term debt is a financial obligation that is scheduled to be fully
satisfied or paid off within the course of 12 months.
Function
There is no hard and fast rule regarding how long-term and short-term debt are
utilized. However, short-term debt tends to be used to deal with revenue
shortfalls impacting day-to-day operations. For example, if a business
experiences a slump in sales and is unable to meet payroll obligations, short-
term financing is sought.
Long-term debt tends to be utilized for capital investments. For example, this
type of financing may be obtained for the purchase of equipment.
Features
Both long-term and short-term debt can be secured or unsecured. Secured debt
is a loan backed by collateral. For example, if a business obtains a loan for an
equipment purchase, the lender takes a lien on the equipment itself. If the
business defaults on the loan--be it short-term or long-term--the lender is entitled
to take possession of the equipment and sell it to attempt to satisfy the balance
on the loan.
Unsecured debt is a loan that is not secured with collateral. In other words, if a
business obtains an unsecured loan--short-term or long-term--the lender is not
able to seize any collateral (property) to use to attempt to pay off the loan
balance.
Benefits
The benefits of short-term and long-term debts include ensuring the ongoing
operations of a business enterprise as well as providing a business with the
ability to purchase necessary equipment to expand operations and develop
markets into the future
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