Advertisement

The Role of Trade Credit and the Cost of Capital

  • Ted Lindblom
  • Gert Sandahl
Chapter
  • 268 Downloads
Part of the Palgrave Macmillan Studies in Banking and Financial Institutions book series (SBFI)

Abstract

Trade credit and other types of working capital, like inventory, may constitute significant components of a long-term investment in capacity expansion, particularly within businesses dependent on working capital, like wholesaling and retailing. Still the treatment of cash committed to these types of working capital is often lacking in consistency; the focus tends to be on net cash flow effects (see for example Allen, 1976; Kroll, 1985; Kaplan and Ruback, 1995; Mills, 1996). The standard approach is to regard the net of the initial working capital cash flow of a project as an investment that will be recovered at the termination of the project. Cash committed to inventory or trade credit in the form of receivables or payables, is thus implicitly assumed to be equally sensitive to changes in the economic environment. This may often, though, be considered as a major simplification or even an anomaly. Different types of working capital are exposed to different kinds of risk (cf. Cooley et al., 1975). Even in the deterministic case of certainty, it may be misleading to only consider net working capital if there is exposure to inflation (cf. Kim, 1979). As we will show in this chapter, a consistent treatment of cash committed to trade credit and inventory may be of vital importance not only for the investment appraisal decision, but also for an accurate determination of the overall cost of capital, and thus the optimal capital structure of the firm.

Keywords

Cash Flow Capital Structure Trade Credit Free Cash Flow Economic Order Quantity 
These keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.

Preview

Unable to display preview. Download preview PDF.

Unable to display preview. Download preview PDF.

References

  1. Allen, B. (1976) ‘evaluating capital expenditures under inflation: a primer’, Business Horizons, December, 30–9.Google Scholar
  2. Aranoff, G. (1992) ‘Capital budgeting with technology choice and demand fluctuations in a simple manufacturing model: sample calculations and observations on output flexibility’, Managerial and Decision Economics, 13, 409–20.CrossRefGoogle Scholar
  3. Ashton D., K. Peasnell and P. Wang (2011) ‘Residual income valuation models and inflation’, European Accounting Review, 20(3), 459–83.CrossRefGoogle Scholar
  4. Bernard, V.L. and T.L. Stober (1989) ‘The nature and amount of information in the cash flows and accruals’, The Accounting Review, 64(4), 624–52.Google Scholar
  5. Biais, B. and C. Gollier (1997) ‘Trade credit and credit rationing’, The Review of Financial Studies, 10(4), 903–37.CrossRefGoogle Scholar
  6. Blinder, A. and L.J. Maccini (1991) ‘The resurgence of inventory research: what have we learned?’ Journal of Economic Surveys, 5(4), 291–28.CrossRefGoogle Scholar
  7. Borde, S.F. and D.E. McCarty (1998) ‘Determining the cash discount in the firm’s credit policy: an evaluation’, Journal of Financial and Strategic Decisions, 11(2), 41–9.Google Scholar
  8. Burkart, M. and T. Ellingsen (2004) ‘In-kind finance: a theory of trade credit’, The American Economic Review, 94(3), 569–90.CrossRefGoogle Scholar
  9. Carpenter, R.E., S.M. Fazzari and B.C. Petersen (1994) ‘Inventory investment, internal-finance fluctuations and the business cycle’, Brookings Papers on Economic Activity, 2, 75–138.CrossRefGoogle Scholar
  10. Chee K. Ng., J.K. Smith and R.L. Smith (1999) ‘Evidence on the determinants of credit terms used in interfirm trade’, The Journal of Finance, 54(3), 1109–29.CrossRefGoogle Scholar
  11. Cooley, P.L., R.L. Roenfeldt and I-K. Chew (1975) ‘Capital budgeting procedures under inflation’, Financial Management, 4(4), 18–27.CrossRefGoogle Scholar
  12. Copeland, T.E. and J.F. Weston (1989) Financial Theory and Corporate Policy (Addison-Wesley, 3rd edn 1992).Google Scholar
  13. Crowder, W.J. and D.L. Hoffman (1996) ‘The long-run relationship between nominal interest rates and inflation: the Fisher equation revisited’, Journal of Money, Credit and Banking, 28(1), 102–18.CrossRefGoogle Scholar
  14. Fazzari, S.M. and B.C. Petersen (1993) ‘Working capital and fixed investment: new evidence on financing constraints’, The RAND Journal of Economics, 24(3), 328–42.CrossRefGoogle Scholar
  15. Francis, J., P. Olsson, and D.R. Oswald (2000) ‘Comparing the accuracy and explainability of dividend, free cash flow, and abnormal earnings equity value estimates’, Journal of Accounting Research, 38(1), 45–70.CrossRefGoogle Scholar
  16. Goedhart, M., T. Koller and D. Wessels (2010) ‘When the balloon goes up...’, Financial Management (14719185), April, 14–16.Google Scholar
  17. Hamada, R.S. (1979) ‘Financial theory and taxation in an inflationary world: some public policy issues’, The Journal of Finance, 34(2), 347–69.CrossRefGoogle Scholar
  18. Horowitz, I. (2000) ‘EOQ and inflation uncertainty’, Int. J. Production Economics, 65(2), 217–24.CrossRefGoogle Scholar
  19. Huyghebaert, N. (2006) ‘On the determinants and dynamics of trade credit use: empirical evidence from business start-ups’, Journal of Business Finance & Accounting, 33(1-2), 305–28.CrossRefGoogle Scholar
  20. Jain, N. (2001) ‘Monitoring costs and trade credit’, The Quarterly Review of Economics and Finance, 41, 89–110.CrossRefGoogle Scholar
  21. Johnson, M.E. and E. Anderson (2000) ‘Postponement strategies for channel derivatives’, The International Journal of Logistics Management, 11(1), 19–35.CrossRefGoogle Scholar
  22. Kaplan, S.N. and R.S. Ruback (1995) ‘The valuation of cash flow forecasts: an empirical analysis’, The Journal of Finance, 50(4), 1059–93.CrossRefGoogle Scholar
  23. Kim, Y.H. (1979) ‘Inflationary effects in the capital investment process: an empirical examination’, The Journal of Finance, 34(4), 941–50.CrossRefGoogle Scholar
  24. Kim, Y.H. and J.C. Atkins (1978) ‘Evaluating investments in accounts receivable: a wealth maximizing framework’, The Journal of Finance, 33(2), 403–12.CrossRefGoogle Scholar
  25. Kroll, Y. (1985) ‘On the difference between accrual accounting figures and cash flows: the case of working capital’, Financial Management, 14(1), 75–83.CrossRefGoogle Scholar
  26. Lindblom, T., G. Sandahl and S. Sjögren (2011) ‘Capital structure choices’, International Journal of Banking, Accounting and Finance, 3(1), 4–30.CrossRefGoogle Scholar
  27. Mian, S.L. and C.W. Smith (1994) ‘Extending trade credit and financing receivables’, Journal of Applied Corporate Finance, 7(1), 75–84.CrossRefGoogle Scholar
  28. Miller, P. and T. O’Leary (1997) ‘Capital budgeting practices and complementarity relations in the transition to modern manufacture: a field-based analysis’, Journal of Accounting Research, 35(2), 257–71.CrossRefGoogle Scholar
  29. Mills, G.T. (1996) ‘The impact of inflation on capital budgeting and working capital’, Journal of Financial and Strategic Decisions, 9(1), 79–87.Google Scholar
  30. Mishkin, F.S. (1992) ‘Is the Fisher effect for real?’ Journal of Monetary Economics, 30(2), 195–215.CrossRefGoogle Scholar
  31. Modigliani, F. and M.H. Miller (1958) ‘The cost of capital, corporation finance and the theory of investment’, American Economic Review, 48, 261–97.Google Scholar
  32. Nilsen, J.H. (2002) ‘Trade credit and the bank lending channel’, Journal of Money, Credit and Banking, 34(1), 226–53.CrossRefGoogle Scholar
  33. Peterson, M.A. and R.G. Rajan (1997) ‘Trade credit: theories and evidence’, The Review of Financial Studies, 10(3), 661–91.CrossRefGoogle Scholar
  34. Rajan, R.G. and L. Zingales (1995) ‘What do we know about capital structure? some evidence from international data’, Journal of Finance, 50(5), 1421–60.CrossRefGoogle Scholar
  35. Schwartz, R.A. (1974) ‘An economic model of trade credit’, Journal of Financial and Quantitative Analysis, 9, 643–57.CrossRefGoogle Scholar
  36. Shinnar, R., O. Dressler, C.A. Feng, and A.I. Avidan (1989) ‘Estimation of the economic rate of return for industrial companies’, The Journal of Business, 62(3), 417–45.CrossRefGoogle Scholar
  37. Van Delft, C. and J.P. Vial (1996) ‘Discounted costs, obsolescence and planned stockouts with the EOQ formula’, International Journal of Production Economics, 44, 255–65.CrossRefGoogle Scholar
  38. Wilner, B.S. (2000) ‘The exploitation of relationships in financial distress: the case of trade credit’, The Journal of Finance, 55(1), 153–78.CrossRefGoogle Scholar

Copyright information

© Ted Lindblom and Gert Sandahl 2013

Authors and Affiliations

  • Ted Lindblom
    • 1
  • Gert Sandahl
    • 2
  1. 1.University of GothenburgSweden
  2. 2.Department of Business Administration of the School of Business, Economics and Commercial LawUniversity of GothenburgSweden

Personalised recommendations