The Impact of Offering Trade Credit on Firms' Profitability

• Date: 01 September 2017
• DOI: http://doi.org/10.1002/jcaf.22298
• Published date: 01 September 2017

29

© 2017 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com).

DOI 10.1002/jcaf.22298

f

e

a

t

u

r

e

a

r

t

i

c

l

e

The Impact of Offering Trade

Credit on Firms’ Profitability

Ala’a Adden A. Abuhommous

INTRODUCTION

Offering trade

credit to customers

may increase market

share, earn customer

loyalty, and/or reduce

cost; hence, a firm’s

financial performance

should be affected.

However, the body of

knowledge has little

empirical evidence

on the relationship

between trade credit

offered and a firm’s

profitability. Thus,

this study aims to

fill this gap, where

it hypothesizes that a firm’s

investment in accounts receiv-

able should be reflected in the

firm’s performance. Further-

more, the relationship between

trade credit offered and the

firm’s profitability may not be

same for all firms. The return

from investing in trade credit

may be different from one firm

to another; thus, we assume

that a firm’s characteristics can

affect the return from grant-

ing trade credit. Therefore,

we divided firms according to

specific criterion; we used the

motivation for granting trade

credit as a criterion to divide

firms. The only study that has

previously examined this issue

was conducted by Martínez-

Sola, García-Teruel, and

Martínez-Solano (2014), who

show that a firm’s profitability

affects the investment level in

accounts receivable. They also

show that a firm’s characteris-

tics can affect the relationship

between accounts receivable

investment and profitability.

Hill, Kelly, and Lockhart

(2012) also find a positive

impact of supply-

ing trade credit on

shareholder wealth.

Despite the impor-

tance of accounts

receivable on the

corporate profitabil-

ity, the empirical evi-

dence of its impact

on firms’ profitability

is scarce. Therefore,

this study attempts to

tackle this issue and

extend our knowl-

edge of the impact of

granting trade credit

on firms’ profitabil-

ity. Our results show

that firms’ profit-

ability is positively affected by

the degree of investment in

accounts receivable. Further-

more, we find that firms with

a high sales volatility are more

profitable from investing in

accounts receivable than firms

with a lower sales volatility.

Offering trade credit is

seen as an important element

of business life, especially for

some firms, where it might

be higher than long-term

assets. Estimates show that

accounts receivable represents

35% of total assets in the

The amount of accounts receivable represents a

large portion of firms’ investment. Thus, the aim

of this article is to investigate the relationship

between the investment in accounts receivable

and firms’ profitability. In addition, we investigate

the impact of trade credit motives (commercial,

operational, and financial) on the relationship

between accounts receivable and profitability.

The results show that firms can increase their

profitability by investing in accounts receivable;

this effect is greater in firms with a highly volatile

demand. Furthermore, we find that firms that

invest higher than the average firms in the indus-

try are more profitable. © 2017 Wiley Periodicals, Inc.

Refereed (Double-Blind

Peer Reviewed)