(a) What is Credit?
(b) Explain three ways by which banks grant credit to customers.
(c) Give two advantages and three disadvantages of credit sales.
Explanation
(a) The granting of permission to pay at a future date for something of value received now is called credit. It is defined as the granting of the use of possession of goods and services without immediately paying for them.
(b) Three ways by which banks grant credit to customers are:
(i) Loan: Banks can give loans to their customers for a short period which includes interest charges. It is usual for banks to require collateral security before they can give loans. Collateral securities are assets which can be converted to cash upon default by customers.
(ii) Overdraft: An overdraft is a facility granted to a customer who operates a current account. This enables him to draw cheques to an agreed maximum over the amount outstanding to his credit in his current account. For example, if he has #600 in his account, he may withdraw #1000. Banks charge interest on overdraft.
(iii) Discounting bills of exchange: Commercial banks discount bills of exchange, that is, they pay cash for bills of exchange before the bills mature.
(c) Advantages of Credit Sales are:
(i) Credit sales enables many firms to meet temporary needs for cash.
(ii) Credit sales brings higher profit.
(iii) There is increase in sales or turnover.
(iv) It reduces the risk of holding stock.
(v) Credit sales makes it possible for consumers to have immediate possession of the goods and services they need even though they do not pay at once.
Disadvantages of Credit Sales are:
(i) Credit customers pay higher than cash customers.
(ii) There is risk of non -payment by the customers.
(iii) The credit customer may be tempted to buy more than what he can afford.
(iv) Credit sales involve a lot of book keeping processes.