Accounts Payable vs. Trade Credit
Accounts payable, the shortened term for trade accounts payable, are balances owed to other parties for goods or supplies purchased on trade credit. Trade credit is a form of purchase financing extended by sellers to buyers. Using trade credit, companies make no cash payments at the time of the purchase but record a liability that they expect to pay off at the end of the trade credit term. Companies may also settle their accounts payable earlier to take advantage of any purchase discount offered by suppliers.
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Inventory Purchase
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Accounts payable and trade credit are directly related to inventory purchases. An inventory purchase normally is the start of a company’s operating cycle. Companies may purchase inventory with cash or trade credit, prolonging or shortening the cash conversion cycle within the operating cycle, a measure of a company’s relative cash position. The longer the trade credit term, the later a company makes its cash payments -- the start of the cash conversion cycle -- and the faster it will collect cash back from sales, all else being equal.
Accounts Payable
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Accounts payable arise because of the time lag between receiving inventory supplies and making cash payments for them. Companies report accounts payable as current liabilities on the balance sheet that they expect to pay off within their operating or cash conversion cycles. To record a trade-credit financed inventory purchase, companies debit the inventory account and credit the accounts payable to increase both the amount of inventory and the outstanding liabilities.
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Trade Credit
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In financing, one party’s credit is another party’s liability, and thus, trade credit and accounts payable are on the opposite sides of the trade financing transaction between the supplier and purchaser. Trade credit as a form of financing has no stated interest rate and often are short term, commonly ranging from 30 to 60 days. Terms of a trade credit are simply stipulated in the invoice by suppliers, such as the due date and the exact amount to settle the account. Sometimes, suppliers may offer a purchase discount to encourage earlier payments.
Purchase Discount
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A trade credit with a purchase discount may be expressed, for example, as 2/10 net 30, meaning that the supplier will offer a 2 percent discount if the buyer can make payments within 10 days, but otherwise charge the full amount if the buyer pays within 30 days. Even though trade credit is considered non-interest bearing financing, a buyer who loses a purchase discount and pays the full amount is indirectly paying an implied interest rate equal to the discount rate. Creditworthy companies often take the purchase discount and obtain financing elsewhere at an interest rate below the discount rate to further save on financing costs.
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