Trade credit may be used to finance a major part of a firm’s working capital when
Options
A) the firm extends more liberal credit terms than the supplier.
B) neither the firm nor the supplier extends credit.
C) the firm and the supplier both extend the same credit terms.
D) the firm extends less liberal credit terms than the supplier.
Answer Explanation
Trade Credit
Trade credits and accounts payables are interchangeably used words those refer to the arrangements to buy goods and service promising future payment. In this arrangement immediate cash payment is not need so, the firm used that cash would be paid for the account can use for additional time. The largest source of short-term financing is trade credit since trade credit is common for all types of firms.
Trade credit could be cost-free or costly; (i) Trade credit is considered as cost-free if there is no discount offer or the firm takes a discount and pay within a discount period instead of paying on a due date though there is a discount offer in credit terms. (ii) Costly Trade Credit: Instead of taking a discount, if the firm sacrifices the discount offer and uses the funds for further days, then the trade credit is considered a costly trade credit.
Working Capital
The amount of money that the business organization requires to meet their day-to-day needs and wants of the business is called Working Capital. Working Capital can be calculated by deducting the current assets from the current liabilities. If the ratio of Current Assets to Current Liabilities is Less than 1 (< 1) then it indicates that the company has Negative Working Capital. if its ratio of current assets to liabilities is less than one.
If the Company has Positive Working Capital then it indicates that the company has sufficient fund to run its daily operations and is able to make investment for further growth. But regardless of everything High Working Capital isn’t always a good thing for the company because it indicates that the business has too many inventory that is only increasing their carrying cost and is not able to invest that extra cash in other growth activities.
MBA,BBA.
I am Smirti Bam, an enthusiastic edu blogger with a passion for sharing insights into the dynamic world of business and management through this website.
I hold a MBA degree from Presidential Business School, Kathmandu, and a BBA degree with a specialization in Finance from Apex College,
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