Today most businesses run on credit and there are various types of credit used in the business world. Probably businesses don’t have enough amounts of cash to meet the day to day needs of business and as well as other business transactions, but through credit, they can meet all these expenses easily. Also the general public various types of credit to enhance their lifestyle. The term “Credit” refers to purchase in which price is not paid in cash, instead a document is given by the purchaser in acknowledgment of his debt. The document is called “Instruments of Credit”. A credit transaction therefore is a protected exchange. Credit involves confidence in the person’s honesty and integrity. Thus the fundamental elements of credit are time and trust.
The term credit and debit are the same from different angles. Lenders extend credit and borrowers receive it. The lender of the creditor has the right to receive payment and the borrower or debtor has the obligation to pay on demand. So credit can be defined as “right to receive payment or obligation to make payment on demand”. However creditor has the right and debtor the obligation for receiving and making payment respectively.
Types of Credit
Credit can be classified on different basis according to its use, on the basis of its maturity and on the basis of the nature of debtor. On the basis of use credit is extended for the following purposes. There are five types of credit which are as under:-
- Investment Credit
- Commercial Credit
- Consumption Credit
- Speculative Credit
- Agricultural Credit
Investment credit is from one of those types of credit, which is commonly used all over the world. It is used for fixed capital or capital goods. If the borrowers spend money on the purchases of machinery, and to cover the cost of building etc. he may use investment credit. Probably at the time of starting business or meeting the huge expenses of business, investment credit takes place.
Commercial credit is extended for short period requirements for financing current business operations, such as production, manufacturing and marketing goods, etc. It is therefore a short term loan and used as working capital. Commercial loans are easy to repay. These types of credit are probably in the form of bill of exchange, promissory note and trade acceptance. Commercial credits are extended by Commercial Banks and commercial finance corporations.
Consumption credit is extended for non-business purposes. A consumer needs credit for the purchase of a car, refrigerator or television for any daily consumption. This loan finally will be paid out of the income of the borrower. These types of credit are extended by commercial banks and commercial finance corporations and used by the general public.
Few types of Credit are also utilized for speculative purposes. The speculative may borrow funds from commercial banks for the nominal purchase of commodities or securities or both with a view to make profit on account of changes in pricing in future.
Agricultural credit is required generally for two purposes. Firstly for marketing of agricultural products and secondly for the improvement and development of agriculture. Short term credit is required for the purchase of seed and manures. Medium term loan is required for the purchase of cattle and implement and long term loans for the tube-wells and machinery. The basic aim of such types of credit is to support the agriculture in the country.
Instruments of Credit
Credit is the basis of modern commerce and trade. By credit, we mean faith or confidence in the financial ability and integrity of a debtor or buyer and his intention to pay. It may take the form of a promissory note or bill of exchange and other instruments of credit. These instruments of credit or documents, which signify the transaction including the amount and the date of promise (future) to make payment and known as “Instrument of credit”.
Negotiable and Non-negotiable Instruments
Credit instruments may be either Negotiable or Non-Negotiable. In case of a negotiable instrument, the legal right passes from one person to another person by the delivery of instruments. But in non-negotiable instruments, the legal right does not pass passing instruments from one party to another. But in some manner laid down by law.
A negotiable instrument includes cheques payable, a promissory note, and bill of exchange. The act recognizes only three instruments of credit, that is, cheque, bill of exchange and promissory note. Following are the main characteristics of ‘Negotiability”.
- The instruments should be freely transferable by the custom of trade.
- Transfer-ability may be
- By delivery.
- By endorsement and delivery.
- Instrument should be in good conditions, free from all defects and cut and clear about its value.
Documents like postal orders, money orders, deposits certificates and bills of lading are not regarded as negotiable instruments.
Hello everyone! This is Richard Daniels, a full-time passionate researcher & blogger. He holds a Ph.D. degree in Economics. He loves to write about economics, e-commerce, and business-related topics for students to assist them in their studies. That's the sole purpose of Business Study Notes.
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