A Transactions Theory of Trade Credit Use

This paper derives a transactions theory of trade credit use from the motives of trading partners to economize on the joint costs of exchange. In the formal analysis, uncertain delivery time is used to generate a demand by firms to hold inventories of both goods and money. Trade credit is viewed as a mechanism that separates the exchange of money from the uncertainty present in the exchange of goods. By forewarning both trading partners of the timing of money flows, credit permits a reduction in precautionary money holdings and the more effective management of net money accumulations.