Finance Guide

Trade Credit is the practice of businesses selling to other businesses and allowing those other businesses to pay for the goods on a deferred basis. The extent of the deferral varies but, for example, invoices which demand payment within 90 days are not uncommon. Sometimes a percentage discount may be given for earlier payment.

Most businesses both buy from and sell to other businesses. Therefore trade credit can be either a boon or a bane for them. If business customers take a long time to make payment on the invoices that have been issued, the selling company can find itself in cash flow difficulties. Even with a healthy order book and a high level of profitability, the company can be affected catastrophically by a lack of cash on hand, meaning it is unable to pay its own bills. On the other hand, by delaying payment to the maximum extent, a company without much operating capital can get by, perhaps using its purchases as inputs to its own business process and selling its own goods, realizing a profit, before the invoice for those inputs comes due. In this way, the purchases can literally pay for themselves and even a company with no money could afford to acquire the inputs needed for its own business processes.

What is Accounting?

What is trade credit?

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Revenue is money received by a company or other organization. For companies, most revenue comes from selling products or services to individuals or other companies. It is also possible for companies to earn revenue through financial investments.

For accounts to identify a company’s revenue over a given period might seem, at first glance, a simple matter. It would surely involve no more than adding up all of the company’s sources of income. However, correctly identifying revenue is, in fact, a little more complex. The complexity arises from instances such as one where there is a gap in time between a company receiving payment for a good or service and actually delivering that good or service. This scenario is extremely common for most businesses. Businesses, particularly those which deal primarily or exclusively with other businesses, often experience delays of up to several months between submitting an invoice and having that invoice actually be paid. In some cases, the converse is also true : companies can receive payment before the good is supplied or the service delivered.

There is, in fact, no general agreement on how to handle this question. Different countries adopt different rules for how revenue in such cases should be declared. Even within countries, rules sometimes change over time.

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A current liability is the opposite of a current asset. It is a financial obligation which a company is expected to have to discharge within a short period of time, sometimes formally defined as one year or the current financial year. Liabilities are anything for which the company will have to pay out money. The most common liability for a company is the payment given to its suppliers for materials used or services required in its own business processes. Although long-term loans are not considered current liabilities, the interest payments due on them are. Other common current liabilities include wage and salary payments due to employees, refunds to customers for defective goods previously supplied, any money to be paid in court through contrary legal judgements such as product liability law suits or complaints by former employees.

When the sum of current liabilities is divided into the sum of current assets, the result is called the current ratio, which financial analysts consider one of the best measures of a company’s liquidity, in others words its financial viability in the short term. When current liabilities become unmanageably large, a company can be forced into bankruptcy even if it has large long-term assets and high levels of profitability.

What is Accounting?

What are Current Liabilities? 

A current asset is a highly liquid asset which is expected to be used up within a short period time. Examples of current assets include cash, inventories of goods, accounts receivable ( in other words, invoices which have been issued for prior delivery of goods or services and are expected to be paid soon), and securities which can readily be sold.

In accounting, a company’s assets are categorized as either current assets or long-term assets. Long-term assets are such things as property and items of capital equipment.

The figure for the value of current assets is also used in conjunction with the figure for current liabilities to produce another figure called current ratio. A company’s current ratio is its current assets divided by its current liabilities. Current ratio is regarded as one of the best indicator’s of a company’s liquidity, that is its ability to cope with its financial burdens in the short term, such as the need to pay the bills of its suppliers, interest on any debt it has or the wages of its staff. Companies can be generally profitable yet run into catastrophic difficulties in the short term through lack of cash.

Industries tend to vary significantly in their need for levels of short term capital.

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A cash flow statement is an accounting document which shows the amount of cash held by a company over a defined period of time. It records the various transactions the company engaged in and how they affected its cash reserves. The cash flow statement may also record the level of other assets which are deemed to be equivalent to cash. To meet this description, the assets have to be highly liquid, meaning they can be sold very easily and thus converted into cash.

Cash flow statements are used primarily to give outsiders an impression of the health of a business. For example, they would be of interest to those thinking of investing in the company, to other companies considering a merger or takeover of the company or to creditors anxious about whether or not they were going to be repaid.

Of course, at a deeper level, a company may have illiquid or intangible assets which may be of great value. For example, patents or copyrights can be immensely valuable assets and reputation or branding can be worth a great deal too even though it is difficult to quantify their worth. A cash flow statement would not include assets such as these and so cannot be considered a comprehensive view of a company’s value.

What is Accounting?

What is cash flow?