Business Credit; Trade Credit; Open Account Credit Terms

Business credit, trade credit and open account credit all refer to extensions of credit primarily for business or commercial purposes. The key characteristics of business to business credit are:

• The selling terms are relatively short;
• Transactions are usually on open account or unsecured, but may be partially secured or secured in full;
• Cash discounts may be offered for payment before the net due date;
• The terms include transactions to manufacturers, wholesalers and retailers, but specifically exclude the consumer;
• The timeliness in reaching a decision whether or not to extend credit is often much more critical in the business setting. Delays in the manufacturing process can increase costs and reduce the quality of perishable goods.

Business credit sales yields a profit on goods sold rather than interest or investment income, which distinguishes it from bank and investment credit.   Unsecured, open-account credit is the most widely used form of domestic business credit. In open-account credit, the creditor reasonably expects the customer to make repeated transactions and generally makes more credit available to the buyer as the outstanding balance is paid. A typical business creditor who sells on open account terms is relying specifically on the full faith and credit of a purchaser. The seller establishes the terms of sale. Open account terms are also called ordinary terms or standard terms, which are discussed in detail in a later chapter.

A secured credit arrangement is one in which collateral is provided to the creditor. By obtaining some form of security, the creditor can reduce repayment risk. Examples where secured credit may be useful are a start-up business or an undercapitalized business or an opportunity to sell an account that cannot justify a high credit exposure. Security is obtained not only when the buyer's financial condition is weak, but in order to guarantee payment if the buyer's financial condition changes. While it cannot strengthen a buyer's financial weakness, a secured credit arrangement does reduce the likelihood of loss. Secured credit is defined in Article 9 of the Uniform Commercial Code.

It is important to note that drafts, trade acceptances and promissory notes are not forms of security. Each of these instruments is written evidence of debt. However, no security attaches to the instrument.

Sales to customers in other countries account for an important portion of U.S. business transactions. Today, there are more companies with more products entering more markets than at any other time in history. The ability to compete in the global marketplace has become a necessity and, as a result, credit has become global. The procedure for an export credit decision includes more elements than for a domestic decision. In addition to the traditional five Cs of credit analysis, other elements such as the risks associated with the economic stability of a country or country risk must be evaluated. The strength and stability of foreign currency versus the exporter's currency play a major role in the success of an international credit transaction. And, of course, the culture and customs of the buyer influence the credit transaction. These factors, country risk, currency issues and culture, add three more dimensions to the five "Cs" of credit.

One final comment:  Trade credit is a source of working capital for a company.  From the point of view of the creditor, trade credit is expensive.  The creditor company must staff the credit department.  It must finance the extension of credit to purchasers.  It must face the possibility of non-payment.

Edited by Michael C. Dennis, author of "1001 Collection Tools and Tips."