What Are the Different Types of Credit Extended to Customers?

Credit may be extended as consumer credit or trade credit, according to the type of customer. Businesses selling to consumers can extend consumer credit through credit cards or installment loans. Businesses selling to other businesses use trade credit.

Credit Cards: These can be issued directly by a merchant or through a third party. Store or merchant credit cards are issued to customers by the company, as a means of building loyalty and as a marketing effort. Often, cardholders are eligible for special discounts and store events or can accumulate points toward rewards, all of which are meant to guide the customer back into the store or onto an online store front. For example, Kohl’s department stores offer charge customers exclusive monthly discounts. Talbot’s offers multiple levels of credit cards, with points accumulating based on purchases and rewards for predetermined purchasing volumes. Private label cards may be carried by the merchants themselves but are generally issued by a mainstream financial institution that manages the credit cards for a fee.

For smaller companies, such private-label cards are not financially viable, and they choose to establish merchant card services, systems to permit the acceptance of major credit cards from financial services institutions or other vendors. Through such services, they can usually accept both MasterCard and VISA. Usually, Discover Card and American Express are established as additional services. In order to acquire merchant card services, retailers and others have to apply and provide their credit information. In addition, there are start-up fees ranging from about $50 to $200, an equipment charge of $250 to $1,500, and other miscellaneous fees. Ongoing costs include an interchange payment of $0.25 to $0.75 per credit transaction, and a discount rate (fee) of 1 to 6 percent of each purchase. There are also monthly statement charges of $4 to $20, plus other fees, depending upon the service.

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For home-based businesses and others that cannot or do not wish to obtain merchant status with credit card companies, third-party firms may fill the gap, particularly for Internet retailers. These companies do not customarily charge monthly or set-up fees but do have a per-transaction charge and a percentage fee based on the purchase price. PayPal is the most widely recognized and used of these services. More recently Intuit created GoPayment, and Square permits acceptance of credit and debit cards via smart phones.

Installment Credit: Some small businesses directly extend installment credit—loans to be paid back in installments over time—to their customers. Typically, the customers are purchasing large-ticket items—such as used cars, bedding, or furniture—that they want or need to finance over time. Some firms build business relationships with finance companies and/or banks for this purpose.

If a company has sufficient capital to provide its own installment payment programs and can assume the risk, it may earn significant revenues on the interest from financing. Customers who receive such credit must pay principal and interest over the life of the loan. The business retains an ownership interest in the purchased item as collateral on the loan (e.g., the car title), so it can reclaim (repossess) the merchandise if the customer fails to adhere to the loan terms. Many smaller used car dealers who promise credit to all customers (no matter how questionable their credit) use this type of financing as a primary source of revenue, sometimes selling the same vehicles to a succession of owners and repeatedly repossessing them. You should determine how this type of credit arrangement fits within your ethics, and the laws in your area, before pursuing such a strategy. The decision to extend installment credit is a business decision, the risks and rewards of which need to be weighed.

Trade Credit: Providing credit directly to business customers is customary practice for manufacturers and wholesalers. Orders may be released with a range of different credit terms. For example, if the product is custom-made or the credit risk is high, it may be sold on cash-in-advance (CIA) terms, requiring prepayment from the customer before either production or shipping. If the customer is new or has credit issues, the product may be shipped with a cash-on-delivery (COD) arrangement, requiring the delivering party to collect payment in full, perhaps in the form of a cashier’s check or the like, prior to completing the delivery. Other credit is extended through the agreement on the day payment will be due—such as 30, 60, or 90 days. If you want to add an incentive for early payment, a discount can be included; for example, the customary 2/10, net 30 is shorthand for a 2 percent discount offered for payment within 10 days; full payment is expected within 30 days. The LSBF is your one-stop destination to know more different types of credits and marketing.

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