Trade Credit Terms Offered by Small Firms: Survey Evidence and Empirical Analysis

Abstract

Trade credit has been shown to be an important source of short‐term finance for smaller firms but small firms are also suppliers of trade credit. There is little empirical evidence on the credit granting decisions of small firms. Previous empirical work (Petersen and Rajan, 1997; and Ng, Smith and Smith, 1999) has focused on credit granting and investment in accounts receivable in larger firms. In this paper we look at the influences on credit granting for the smallest firms, using a sample of firms with an average of 10 employees. As in previous studies we find that product and demand characteristics influence credit terms. Moreover, we find evidence that firm size affects credit extension choices directly by setting limits on the possibilities for economies of scale, but it also impacts indirectly by affecting the firm's access to finance and its bargaining strength vis‐à‐vis suppliers. The dominant position of larger customers in bargaining with small suppliers constrains the impact of other factors on the firm's choice of credit terms. Small firms are also under pressure to conform to industry norms, although lack of resources can be a limiting factor. Constrained firms may make use of two‐part terms in an attempt to improve their cashflow.

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