There are two main types of credit which is given to either individuals or companies to defer payments on goods or services. The term credit, in modern finance, is used to refer to the trust allowing a party to provide goods or services to another party with the promise for future payment on the same goods or services. Finances, or hard money, also fall into the realm of credit where a sum is granted to one party for the promise of future payment or payments to return the sum granted. When finances are involved, there is generally an interest charge due on the money to promise a return for the person who loaned the money to the borrowing party. Credit is always granted by a lender or creditor to a debtor or borrower. Credit does not always refer to monetary payment for goods, services or borrowed money. The term is also used in situations where the debtor, or borrower, is promising to provide different goods and services as payment.
How is Credit Granted?
The granting of credit is usually dependent on the financial stability, or credit worthiness, of the debtor. Credit worthiness can be determined, and credit granted, in a trade credit situation by a lending company’s credit manager. This is the person who analyzes the financial statements and previous trade references of the person looking for credit terms. Credit worthiness in consumer credit situations is normally determined by analysis of the consumer’s credit history with other lenders. Someone who either holds a large number of loans, beyond what their income can pay, or has a slow or non-paying history with other lenders will generally find it difficult to borrow additional funds from lenders.
Trade credit is reserved for companies looking to obtain goods or services in exchange for a deferred payment, or series of payments. Companies who offer goods and services to their other companies for deferred payment often utilize a group of employees who are trained in obtaining and analyzing financial information pertaining to the borrower. These employees will generally have the initial contact with the customer to request their most recent financial statements; also utilizing public information posted regarding the financial worthiness of the customer. Once the previous company credit history is determined, these specialized employees will either grant the customer credit or require cash and carry terms on the account. In certain company situations, such as sole proprietorships, the financial worthiness of the individual company owner may come into play in determining whether the company will be granted trade credit.
Consumer credit is the most common form of credit that is granted between lenders and borrowers. Any company who provides good, services or money to consumers has the ability to grant consumer credit. The definition of consumer credit is the granting of goods, services or money provided to a consumer without immediate payment required in turn. Generally, consumer credit includes credit cards, either bank or store issued, motor finance loans, instalment cash loans, retail instalment loans and home mortgages. In some countries, such as the US, mortgage loans are not included in consumer credit due to the sheer size of the market for that lending category. Consumer credit lending usually includes interest, charges and arrangement fees in additional to the dollar amount being loaned. This additional amount due to the lender by the borrower is called the “cost of credit”. The true cost of credit is almost always required to be presented by the lender to the borrower, prior to entering into a binding agreement, in the form of a stated annual percentage rate.
Credit affects almost everyone living in civilized society. Most major purchases are made utilizing some form of credit agreement between a lender and a borrower. With very few exceptions, most consumers utilize some form of credit to maintain their lives on a daily basis. There are also very few companies in the world that do not work on a trade credit or barter basis with their vendors in order to maintain their inventories and ability to sell to their own customers.