Association for Financial Professionals (AFP) Practice Exam

What economic benefit does trade credit provide to a company?

1. It reduces net working capital requirements

2. It avoids incurring debt or liquidating investments

3. It increases cash reserves

4. It guarantees supply chain financing

The correct answer is: It avoids incurring debt or liquidating investments

Trade credit provides significant economic benefits to a company primarily because it allows a business to purchase goods or services and defer payment to a later date, which can help in managing cash flow effectively. By utilizing trade credit, a company can avoid incurring additional debt or having to liquidate investments to meet immediate cash needs. This is particularly advantageous as it helps the company maintain liquidity for other operational needs or investment opportunities without the pressure of additional borrowing costs or selling off assets at potentially unfavorable rates. While some of the other options, like reducing net working capital requirements, increasing cash reserves, or providing guarantees for supply chain financing, might have indirect implications related to trade credit, the most direct economic benefit is the ability to avoid debt and safeguard investments. Utilizing trade credit optimally helps companies leverage their cash flows without compromising their financial stability.