Effects of financial distress and financing constraints on trade credit provisions

What is it about?

The purpose of this study is to evaluate the effects of financial constraint and financial distress on trade credit provisions in the UK FTSE 350 listed firms. This study employs panel data in the estimation of the determinants of accounts payables and accounts receivables of the UK FTSE350 firms from 2009 to 2017. This study finds that financial distress has significant positive effect on accounts payables and a significant negative effect on accounts receivables. Financial constraints has significant negative effect on accounts payables and a significant positive effect on accounts receivables. Trade creditor desiring to maintain an enduring product-market relationship grant more concessions to customer in financial distress. The amount of trade credit that sellers provide to financially constrained firm is an increasing function of the buyer’s creditworthiness. The urgent cash needs of financially distressed firms lead them to sell trade receivables to factoring company leading to reduction in trade receivables. Firm facing external financing constraints increase trade credit to customers in anticipation of cash flow inflow to enhance liquidity.

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Why is it important?

This study shows that financial distress and financial constraints mutually reinforce each other in their effects on trade credit provisions, and firm’s financing condition contributes to divergence in trade credit policies.

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