Keeping track of trade credits can help a company improve its liquidity. If you work in an organization’s accounting department or are part of its management team, being familiar with trade credits can improve your performance.
Knowing what they are and how they work is a valuable skill that you can acquire through research.
In this article, we look at what business credits are, why they’re important, what their calculation formula is, how you can reduce them, and how they compare to non-business credits.
What are business credits?
Credit Meaning in Accounting
Trade credits are the total amount of money that an organization has invoiced for goods or services that it has already delivered but have not yet been paid for by the customer.
The company usually keeps track of them with the help of formal invoices that make up the accounts receivable aging report.
The organization’s collections staff use this report to identify customers who have fallen behind on payments and to contact them to make the necessary payment arrangements.
Why are business loans important?
Business loans are important because they help ensure that a business has steady cash flow. This is especially true for small and medium-sized businesses that may not have large cash deposits and are more easily affected by payment delays.
They may also allow an organization to have its regular customers purchase goods or services on credit and pay by a specified date or in installments.
What is the commercial credit formula?
The formula for trade credits is:
Trade credits = debtors + notes receivable
Therefore, to calculate trade receivables, you need to analyze the company’s balance sheet to identify and add up all debtors and receivables.
You can use another formula, called the trade credit days formula, to determine how long it should take for a debtor to settle their invoice with your company. The formula is:
Commercial collection days = trade debtors / revenue x 365
Accounts Receivable Example
Rose Aloe, a manufacturer of beauty products, has on its balance sheet a total of $20,000 from debtors who purchased its products and have not yet paid for them, and $15,000 in notes receivable, which are payments from customers who purchased the products. and promised to pay on a certain date. The company’s annual revenue is $90,000. You can calculate accounts receivable by applying the formula:
20,000 + 15,000 =* 35,000***
You can also use the trade credit days formula to estimate when the business can expect to receive payment for goods supplied:
35,000 / 90,000 x 365 =* 141.94***
Therefore, the company takes an average of 141 days to collect an invoice.
Tips for reducing business credits
Trade credits can be essentially reduced by having customers pay their invoices shortly after receiving the good or service. Some tips to achieve this are:
- Establish clear payment terms. Setting clear guidelines on how and when your business is paid for delivered goods or services often results in customers paying their invoices promptly. One way to speed up payments is to tag invoices with due, which means that payment must be made immediately after receipt of the invoice .
- Send invoices immediately. By sending invoices immediately after fulfilling your obligation to the customer, you can avoid a payment delay. Try to send it within a maximum period of 48 hours.
- Use email. Instead of sending invoices via traditional mail, you can try using email as this is likely to speed up the process.
- Asking for a deposit on larger orders If providing extra time to pay after delivery is essential to your business, you might consider asking for a deposit before the good or service is delivered. This can improve your organization’s liquidity by gaining access to a portion of the funds due even before the customer receives the product or benefits from the service.
- Consider offering early payment discounts. Offer your customers a discount for paying early and clearly specify the time frame for using the discount. A relatively small discount can incentivize customers to pay on time.
- Take action on late payments. If you have customers who are not making their payments on time, you need to take immediate action. One method you can use is a collection agency, as they are specialized in these situations and will likely make sure you get paid in exchange for a commission.
Commercial credits versus non-commercial credits
Non-business credits are income an organization receives from sources other than its regular business activities. Unlike commercial credits, which always require the generation of a receipt, non-commercial credits do not.
Like trade loans, non-trade loans are classified as current assets. The company can choose to transfer them to the category of non-current assets if it expects that their payment will take more than one year.
Some of the most common non-commercial loans are:
- Loans that the company makes to its employees
- Parts of employee salary that the company pays in advance
- Payment of interest on loans granted by the company
- Insurance claim by the company
How to calculate credit sales
You can use several methods to calculate your company’s credit sales. Here are the three methods and steps to calculate credit sales:
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Take the sum of individual credit sales
Find the total amount of credit sales by keeping your debtors account up to date. This means updating it for each sale made on credit. This will give you greater accuracy by taking into account changes in product prices in addition to all cash sales.
If you want a credit sales total for a specific time period, enter a credit sales amount at the beginning of that period. Please note that credit sales amounts include sales tax.
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Calculate credit sales from total sales
You can also calculate credit sales from total sales. To calculate total sales, multiply the number of items sold by their selling price. To begin calculating credit sales, determine the cash received.
Once you have these figures, determine credit sales by reducing total sales by the amount of total cash received.
For example, let’s say you plan to sell 100 televisions at $200 each. This leaves you with sales of $20,000.
Now, let’s say customers paid an average of $50 in cash for the 100 TVs, leaving you with $5,000 in cash received. To calculate credit sales, reduce total sales by total cash received as follows:
$20,000 – $5,000 = $15,000
Credit sales are equal to total sales minus cash received.
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Calculate credit sales from accounts receivable
You can also calculate credit sales using accounts receivable.
For example, determine the initial value at the beginning of a year that appears on the company’s balance sheet. Let’s say it has a starting value of $20,000.
Next, find the ending accounts receivable. This refers to the value at the end of the year, which you can also locate on the balance sheet. Let’s say it’s $10,000.
Now, determine the cash received by looking at the company’s records. Let’s say this amount is $40,000.
Once you have these figures, take the difference to calculate credit sales. You can calculate credit sales as follows:
Credit Sales = Cash Received – Beginning Accounts Receivable + Ending Accounts Receivable
Using the example, you’ll calculate credit sales as follows:
$40,000 – $20,000 + $10,000 = $30,000
In this case, you have $30,000 in sales for the year.
