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Determinants of accounts payable in Trade Credit Introduction Trade credit is widely adopted by the companies all over the world. And The accounts receivable and the account payable are included in most companies’ balance sheet (Niskanen & Niskanen, 2006).For example, more than eight percent corporate sector transactions are made on trade credit in the UK (Wilson & Summers, 2002), and in the US trade credit exceeded the business lending of the entire banking system as an important form of finance (Lee & Stowe, 1993). Deferred payment to suppliers or purchasing on credit that represents the trade credit has shown to be a significant means to offer companies a short-term finance option and a component of money supply. In addition, trade credit is also a crucial tool to build the relationship between the buyers and suppliers (Paul, 2008). As the role the trade credit plays is getting even more significant in corporate finance, many different theories with empirical studies or statistic methodology have been put forward to explain this situation. Even so many studies on trade credit concentrate on the supply side of this issue and mainly describe the reasons for non financial firms offering credit; to some extend the trade credit is equally important (Paul & Wilson, 2007). This literature review focus on account payable determinants and explore what mainly drive firms to accept credit from others. Determinants exploration Past studies show a number of reasons for the demand of trade credit, such as the transaction cost, financial cost, financial benefit, operational considerations, seller compliance and marketing considerations and so on. We will probe into the reasons on the side of ‘account payable’. 1.1 Supply of trade credit Niskanen and Niskanen (2006) used statistical method to certify the result concerning supply of trade credit is clear and expected. The estimated purchases are statistically significantly related to accounts payable. The explanation is easy to understand that the growth in the supply of the trade credit from the sellers must bring more use of it. The companies like to utilize this kind of corporate financing method. 1.2 Creditworthiness Small firms are often suppliers of trade credit, despite the difficulties that this can cause them, and there is little empirical evidence on the credit granting decisions of such firms (Wilson & Summers, 2002). However, Niskanen and Niskanen (2006) suggested that the results concerning size and age partly confirmed the notion that lager and older firms would use less trade credit than smaller and younger firms because of relatively smaller investment opportunities. The interpretation showed that large and old firms’ creditworthiness is better, and they are more often offered trade credit. 1.3 Firm’s business environment Attractive and flexible terms may lead to a longer-term relationship, because the demand for a product may vary according to trade credit terms offered (Wilson & Summers, 2002). As far as the buyer is concerned, the offer of integral parts would be expected to make credit more attractive, but they are also in essence an offer of financial benefit as an inducement to trade or to continue trading with a particular supplier (Paul & Wilson, 2007). Other factors that may influence the demand for credit include internal organization, economic conditions, sector performance and the market in which the firm’s business operates and so on. For instance, when the economy goes down in a recession cycle and financial distress, generous terms may be required (Paul & Wilson, 2007). 1.4 Growth Rapidly growing firms may theoretically have better investment opportunities than other firms do and are thus willing to use more trade credit as a partial source of financing for their new investments. Just like the example, the company in growing stage would supply generous trade credit terms to satisfy the customers and therefore may expect to demand more credit to finance them (Paul & Wilson, 2007). However, Niskanen and Niskanen, (2006) argued that in fact neither positive growth variable nor negative one is correlated with the value of account payable held by firms.

1.5 Asset maturity The maturity of the planned investment is another consideration in trade credit decisions. Horne (1995) suggested that the traditional prescription in corporate finance is to adapt a matching approach: finance the short-term needs with the short-term funds and long-term needs with long-term funds, taking into account all due uncertainty considerations. Therefore, current assets are financed by using current debt such as account payable, while the longer-term assets are financed by using longer-term debt or equity (Niskanen & Niskanen, 2006). The firms with more short-term assets are supposed to demand more short-term trade credit in general and would have more account payable in particular (Deloof & Jegers, 1999). 1.6 Banking relationships and bank competition Niskanen and Niskanen (2006) used the variables which are related to the firms’ bank relationships and the banking environment in the country where the company is located. From the two relationship variables, we saw a clear and significant sign which suggested that firms operating in competitive banking markets use more trade credit. Because the firms operating in competitive banking markets have problems in getting bank loans and therefore use more trade credit. 1.7 Financial troubles In the sample firms during the period 1994-1997, every third sample firm was subject to loan restructuring (Niskanen & Niskanen, 2006). Loan restructurings are a very significantly powerful signal of financial troubles, and the firms subject to them can be expected to take advantage of whatever trade credit that they can be offered. Consequently, the companies with financial problems are more likely to have higher level of account payable. 1.8 Cost of alternative capital In the statistical test, the market interest rate variable is significant (Niskanen & Niskanen, 2006). This indicates that a rise in the interest rates increases the use of trade credit. When the market interest rate increase, the risk premium will increase, which means the investors expect more profit for a given amount of funds than before. When the cost of alternative capital increases, the buyers are expected to utilize the credit terms they can get. However, when the market interest rate decreases, the cost of alternative capital will fall. The buyers would seek the cheaper way for corporate finance. The financial benefit arises from the fact that the firm’s inventory is financed by the seller (Paul & Wilson, 2007). Summers and Wilson (2000) argue that the time lag between receiving goods and paying for them enables the buyers to earn interest on the money waiting to be paid and thus benefit from avoiding the financing costs of borrowing. 1.9 Transaction cost Wilson (1999) applied the model which is developed by Elliehausen and Wolken (1993) to the small companies in UK. In this model, it is assumed that the aulity of trade credit demanded can be responded by the firm’s account payable and is a function of transaction costs and financial components. Therefore, Wilson and Summers (2002) further developed this model by adding more aspects of trade credit demand into it, such as operational considerations, potential for non-compliance by the seller, benefits from supplier marketing and customer base. The argument here is that the reduction in the amount of transaction on the buyer’s bank accounts reduces bank charges. Similarly, the use of trade credit offers a better solution of when bills are to be paid and therefore the cash management gets better (Paul & Wilson, 2007). 1.10 Operational conditions Paul and Wilson (2007) state that if the production and sales cycle gets longer, the firm will have to wait for its cash back for a longer time. Companies normally turn to outside finance to fund such operations and seasonality, such as trade credit which is also affected by the length of the production cycles. However, because of the nature of their inventory, a large amount of cash is tied up in this production process and thus this will influence the demand for trade credit. Nevertheless Summers and Wilson (2000) argue that the high level of inventory may lead to poor inventory management, some firm maintain high inventory levels to meet customer demand in order to avoiding the inventory-outs, which can damage customer goodwill. 1.11 Asymmetric information The demand for trade credit and the length of time buyers take to pay may depend on how confident they are about the quality of the goods or services they receive (Paul & Wilso, 2007). For buyers, credit provides them with protection against product risk being unreasonably passed on by the seller. The seller may offer an early payment discount to make the buyer take on the production risk at an earlier stage, since the shorter the inspection period, the less likely it is that product flaw will be revealed. Deloof and Jegers (1999) state that asymmetric information between informed firm insiders and external capital providers could lead to financing constraints and pecking order behavior. It is supposed that there is a pecking order in the financing of the firm; the company is expected to generate cash internally which would be higher in the pecking order than trade credit. Therefore, if the firm’s demand for the fund is given by the internally generated cash, the demand for trade credit would decrease. Conclusions So far there has been very little research on determinants of trade credit. This article demonstrates an empirical exploration on the factors that determine the trade credit demand. Trade credit may play a significant role in corporate finance because the suppliers have much cost advantages over financial institutions in providing credit to their customers (Deloof & Jegers, 1999). We confirm that the volume of the trade credit the buyers take is determined by the amount they need and the amount of internally generated cash. Furthermore, we find internal organizations, economic conditions, sector performance and the market in which the firm’s business operates are all included in the firms’ business environment, which has positive relationship with the trade credit the buys can get. The size of the firm directly impacts the availability of the trade credit that the company can get. The large and old firms’ creditworthiness is better, and they are more often offered trade credit. Besides, the relationship with suppliers and banks can also influent the credit terms, and the firms operating in competitive banking markets tend to use more credit. Also the financially constrained companies and those suffered with the rise of market interest rate, are more likely to have higher level of account payable. Furthermore, operational conditions and the maturity of the firms’ investment also could lead to attractive and flexible terms. And the firm’s growth opportunity will promote the demand for trade credit. In addition, according to the matching theory, the firms with more short-tern assets are more likely in high demand of trade credit to finance them.