The impact of working capital financing costs on the efficiency of trade credit
By Sripad Devalkar, Harish Krishnan
Production and Operations Management | April 2019
Production and Operations Management | April 2019
Citation
Devalkar, Sripad., Krishnan, Harish. (2018). The impact of working capital financing costs on the efficiency of trade credit Production and Operations Management onlinelibrary.wiley.com/doi/10.1111/poms.12954.
Copyright
Production and Operations Management, 2018
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Abstract
One of the arguments given to explain the widespread use of costly trade credit in supply
chains is that trade credit enhances efficiency by resolving moral hazard problems. In this paper,
we consider the impact of demand shocks on this efficiency role of trade credit. We show that
as the probability of a negative demand shock increases, the amount of trade credit necessary
to resolve moral hazard also increases. In other words, as economic conditions weaken (i.e. as
the probability of low demand increases), more trade credit is required to coordinate the supply
chain. The working capital financing costs associated with trade credit can impose a burden
that makes it infeasible to coordinate the supply chain. We show that an appropriately designed
reverse factoring program can provide suppliers with access to inexpensive credit necessary to
finance the working capital associated with trade credit and restore supply chain efficiency.
chains is that trade credit enhances efficiency by resolving moral hazard problems. In this paper,
we consider the impact of demand shocks on this efficiency role of trade credit. We show that
as the probability of a negative demand shock increases, the amount of trade credit necessary
to resolve moral hazard also increases. In other words, as economic conditions weaken (i.e. as
the probability of low demand increases), more trade credit is required to coordinate the supply
chain. The working capital financing costs associated with trade credit can impose a burden
that makes it infeasible to coordinate the supply chain. We show that an appropriately designed
reverse factoring program can provide suppliers with access to inexpensive credit necessary to
finance the working capital associated with trade credit and restore supply chain efficiency.
Professor Sripad Devalkar is an Associate Professor of Operations Management at the Indian School of Business (ISB). His research interests fall under two broad themes - agricultural operations and Non-profit and public sector operations. Within these thematic areas, he is interested in understanding issues related to supply chain management and how the interaction of operational, financial, and risk management decisions affect outcomes.
He teaches the core Operations Management course in the PGP programme at ISB, as well as, an elective course on Logistics and Supply Chain Management.
Sripad Devalkar