The Relation between Trade Credit Structures and Firm- and Supply Chain Profitability

Mathias Brink Lorenz

Student thesis: Master thesis

Abstract

Capital tied in Trade Receivables and Trade Payables is denoted Trade Credit which is a component of Working Capital. During and following the financial crisis, the access to funding has been constrained for many firms and at the same time the costs of the scarce funding have increased. The limited access to funding has sparked a need for firms to look elsewhere and Trade Credit has thus been increasingly important for firms to consider as a funding source, as a decrease in Trade Receivables or an increase in Trade Payables is equivalent to an increase in available funding for the firm. As Trade Credit becomes a more important part of a firms funding strategy it inevitable becomes more important to understand the drivers of Trade Credit and assess how Trade Credit is related to firm Profitability as well as Supply Chain Profitability. These factors are my main motivation for my Thesis and I have addressed them in my overall research question: What is the relation between Trade Credit and Profitability and can firm- and Supply Chain Profitability be improved by changing Trade Credit structures? The research question has been elaborated with three sub-questions which have been answered in the thesis. In section 2 I aimed at answering the first sub-question: Why do firms offer Trade Credit and which cost factors are related to Trade Credit? The conclusion is that firms offer Trade Credit due to superior credit risk evaluation, to promote sales, to signal product quality, to promote company reputation, to use Trade Credit as a competitive parameter or to save administration costs by bundling invoices. In section 2 and 3 I have hypothesised that the cost factors of Trade Credit can be described using the concept of carrying costs and shortage costs which combined represents a non-linear relation between Trade Credit and firm Profitability as there are both costs and benefits associated with granting and receiving Trade Credit. This relation is covered by the second sub-question: What is the relation between Trade Credit and firm Profitability? The hypothesised non-linear relation based on carrying costs and shortage costs has been confirmed in section 4 which is a quantitative multivariate regression analysis using cross-sectional data from Scandinavian wholesale firms. In section 2 and 3 I also hypothesised that for a Supply Chain, the overall cost of Trade Credit can be lowered if the Trade Credit is provided by the firm with the lowest carrying costs. This relation is covered by the third sub-question: What is the relation between Trade Credit and Supply Chain Profitability? That the total cost of Trade Credit in a Supply Chain can be lowered by collaborative finance where the Trade Credit is provided by the firm with the lowest cost of Trade Credit, has been confirmed in section 5 which is a qualitative analysis using data from two sample Supply Chains within the bunker oil wholesale industry. The final conclusion is that the relation between Trade Credit and Profitability is non-linear for both Trade Receivables and Trade Payables and that the impact on Profitability is determined by the carrying costs and shortage costs of each component. Furthermore, the overall Profitability in Supply Chains can be improved by implementing collaborative finance where the Trade Credit is provided by the firm with the lowest costs of Trade Credit.

EducationsMSc in Finance and Strategic Management, (Graduate Programme) Final Thesis
LanguageEnglish
Publication date2014
Number of pages87