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Trade credit and SME profitability

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Abstract

Financial literature discusses the motives for trade credit provision by suppliers in depth. However, there is no empirical evidence of the effect of granting trade credit on the profitability of small and medium-sized firms. We examine the profitability implications of providing financing to customers for a sample of 11,337 Spanish manufacturing SMEs during the 2000–2007 period. This article also examines the differences in the profitability of trade credit according to financial, operational, and commercial motives. The findings suggest that managers can improve firm profitability by increasing their investment in receivables and that the effect is greater for financially unconstrained firms (larger and more liquid firms), for firms with volatile demand, and for firms with bigger market shares.

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Notes

  1. In trade credit arrangements it is very common to offer early payment discount to the customer. The most common payment term is 2/10, net 30 (Ng et al. 1999), by which a customer takes a 2 % discount on the purchase price if the payment is made within 10 days; otherwise, the payment is in full within 30 days. This translates into an over 40 % annual rate.

  2. GDP growth rate was extracted from Eurostat.

  3. NACE is the European classification of economic activities. NACE is a classification derived from the ISIC (International Standard Industrial Classification) to enable international comparability.

  4. We perform the Hausman (1978) test; if the null hypothesis is rejected, only within-group estimation is consistent; if accepted, random-effects estimation is the best option, since not only is it consistent, it is also more efficient than the within-group estimator.

  5. The investment in trade credit may be influenced by the firm's profitability, and the positive relationship between trade credit and return on assets could be explained if more profitable firms grant more trade credit to their customers because of their greater financial capacity.

  6. We also test for the existence of a non-linear relationship between trade credit and profitability including variable REC2 in the regression. Results reject this hypothesis and confirm a linear relationship.

  7. The results do not change if we eliminate control variable SIZE from the estimations.

  8. Additionally, we analyse the effect of inventories on the profitability of receivables. In line with Bougheas et al. (2009) and Daripa and Nilsen (2005), we find that the profitability of receivables is higher for lower inventory firms.

  9. The relation receivables-profitability does not change if we include control variables squared. Moreover, in general, the relation between ROA and control variables does not change either.

  10. However, when time dummies are excluded we find a positive association between GDP growth and firm profitability for OLS and FE estimations. When economic conditions are good, i.e. high GDP growth, firms will enjoy a higher profitability.

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Acknowledgements

The authors gratefully acknowledge the helpful comments and suggestions received during the review process. This research is part of the project 15358/PHCS/10 financed by “Fundación Séneca” Science and Technology Agency of the Region of Murcia (Spain) – (Program: PCTIRM 1114), and the project SEJ 6828 financed by the Economy, Innovation and Science Agency of Andalusia (Spain). We also acknowledge support from “Fundación CajaMurcia”.

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Authors and Affiliations

  1. Department of Accounting and Finance, Faculty Social Sciences and Law, University of Jaen, Jaén, Spain

    Cristina Martínez-Sola

  2. Department of Management and Finance, Faculty of Economics and Business, University of Murcia, Murcia, Spain

    Pedro J. García-Teruel & Pedro Martínez-Solano

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  1. Cristina Martínez-Sola
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  2. Pedro J. García-Teruel
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Correspondence to Pedro Martínez-Solano.

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Martínez-Sola, C., García-Teruel, P.J. & Martínez-Solano, P. Trade credit and SME profitability. Small Bus Econ 42, 561–577 (2014). https://doi.org/10.1007/s11187-013-9491-y

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