(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.

Answer Details

(a) Meaning of credit

Credit is an arrangement by which a buyer receives goods, services or money now and pays for them at a later agreed date, or by instalments, instead of paying immediately. It is based on trust and the confidence that the debtor will be able and willing to pay in the future.

(b) Three ways by which banks grant credit to customers

• Bank loan: The bank lends an agreed lump sum to the customer for a fixed period. The full amount is credited to the customer's account at once, and the customer repays the principal plus interest over the agreed period.
• Bank overdraft: The bank allows a current-account customer to withdraw more than the balance in the account up to an agreed limit. Interest is charged only on the amount actually overdrawn.
• Discounting of bills of exchange: The bank buys a customer's bill of exchange before its maturity date, paying the customer the face value less a discount (interest), thereby providing immediate cash.

(c) Advantages of credit sales

• They increase sales and turnover because customers who lack ready cash are still able to buy.
• They help to attract and retain customers, thereby building goodwill and a lasting business relationship.

Disadvantages of credit sales

• There is the risk of bad debts if some customers fail to pay.
• The seller's working capital is tied up in debtors, which may create cash-flow problems.
• Extra costs are incurred in keeping records of debtors and in following up and recovering debts.