The value of trade credit under risk controls

Abstract

Trade credit is widely used by companies to obtain external funds. The extant literature has demonstrated that trade credit benefits the buyer and the supplier in multiple ways, but might still induce various issues. In this paper, we focus on the impact of trade credit on growing small businesses and their suppliers. By looking into a one-supplier-one-retailer supply chain under a multiple-period setting, we study the expansion and inventory policies of the retailer with his consideration of risk control, which is critical for any small business. We also take into account the supplier's risk control decision on whether trade credit will be extended. We further numerically mimic various growth scenarios of the retailer. Interestingly, we find that, in contrast to the traditional wisdom, trade credit offered by the supplier not only increases the profits of both parties, but also reduces the retailer's default risk, as long as the supplier can apply appropriate risk controls. In addition, we show that offering trade credit does not necessarily attract retailers to act aggressively in general. Under the supplier's risk controls, the retailer's growth rate can be quite insensitive with the term of trade credit.