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79 Fed. Res. Bull. 929 (1993)
The Demand for Trade Credit: An Investigation of Motives for Trade Credit Use by Small Businesses

handle is hein.journals/fedred79 and id is 1737 raw text is: Staff Studies The staff members of the Board of Governors of the Federal Reserve System and of the Federal Reserve Banks undertake studies that cover a wide range of economic and financial subjects. From time to time the studies that are of general interest are pub- lished in the Staff Studies series and summarized in the FEDERAL RESERVE BULLETIN. The analyses and conclusions set forth are those of the authors and do not necessarily indicate concurrence by the Board of Governors, by the Federal Reserve Banks, or by members of their staffs. Single copies of the full text of each study are available without charge. The titles available are shown under Staff Studies in the list of Federal Reserve Board publications at the back of each BULLETIN. STUDY SUMMARY THE DEMAND FOR TRADE CREDIT: AN INVESTIGATION OF MOTIVES FOR TRADE CREDIT USE BY SMALL BUSINESSES Gregory E. Elliehausen and John D. Wolken Prepared as a staff study in spring 1993 Trade credit-credit extended by a seller who does not require immediate payment for delivery of a product-is an important source of funds for busi- ness customers. In 1987, such credit accounted for about 15 percent of the liabilities of nonfarm nonfi- nancial businesses in the United States, approxi- mately the same percentage of liabilities as these firms' nonmortgage loans from banks. Trade credit apparently is especially important for small busi- nesses: In the same year, it accounted for about 20 percent of small firms' liabilities. Businesses that choose to finance their purchases through trade credit have several options for pay- ment: They may pay the supplier promptly and in so doing receive a cash discount; wait until the bill's due date and consequently pay the interest cost implicit in forgoing the cash discount, at a rate frequently higher than the rate on credit from insti- tutional lenders; or pay late, after the bill's due date, and thereby risk incurring additional costs in the form of explicit interest charges or penalties, or both. Although trade credit is an important source of funds for small businesses, little has been known about the reasons business customers use it. Theoreticians have linked the use of trade credit to a transaction motive-a desire to realize econo- mies in cash management-and to a financing motive-use of trade credit because credit from other sources, particularly from financial institu- tions, is limited. These theories are not mutually exclusive, yet no earlier study has integrated the two in a single theoretical or empirical model. Previous studies have focused on one or the other of the motives, and available empirical evidence on trade credit use, especially by small businesses, is limited. This paper presents a model of trade credit demand that incorporates both the transaction and financing theories of trade credit use. The model relates characteristics of the firm to trade credit use associated with either the transaction or the financ- ing motive. One important feature of the model is a

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