Definition
Credit refers to the reputation and financial standing of an individual or organization, the sum customers can claim before requiring payment, funding for purchases or services on borrowed money, an accounting entry recording a sale or liability, and any payment into an account. Here are more detailed descriptions:
- Financial Standing and Reputation: The reputation and financial standing of a person or organization based on their ability to meet financial commitments.
- Customer Payment Terms: The sum of money that a trader or company allows a customer before requiring payment.
- Borrowing Mechanisms: The funding of purchases by members of the public using money borrowed from finance companies, banks, and other money lenders.
- Double-Entry Bookkeeping Entry: An entry on the right-hand side of an account in double-entry bookkeeping that usually shows a sale or a liability.
- Account Payment: Any payment into an account.
Examples
- Consumer Credit: When an individual uses a credit card to make everyday purchases, they are utilizing consumer credit. They are essentially borrowing money from the credit card company and will pay it back later, often with interest.
- Trade Credit: A company purchasing raw materials from a supplier may receive trade credit. The supplier allows the company to take possession of materials and pay for them at a later date.
- Credit Entries: In double-entry bookkeeping, when a company makes a sale on account, this transaction is recorded as a credit entry in the company’s accounts receivable ledger.
Frequently Asked Questions (FAQs)
What is a credit score?
A credit score is a numerical expression of a person’s creditworthiness based on the analysis of their credit files. It is important for lenders to assess the risk of lending money.
How does consumer credit impact the economy?
Consumer credit allows individuals to purchase goods and services beyond their immediate cash availability, thus stimulating economic activity and growth.
What is the difference between credit and debit in accounting?
In accounting, a debit increases asset or expense accounts and decreases liability or equity accounts, whereas a credit increases liability or equity accounts and decreases asset or expense accounts.
Why is credit important for businesses?
Credit allows businesses to purchase necessary goods and services even when they don’t have sufficient cash on hand. It also helps in managing cash flow and investing in growth opportunities.
How do credit terms affect a company’s cash flow?
Longer credit terms can delay cash inflows, potentially impacting short-term liquidity. However, they can also foster better relationships with clients who appreciate the extended terms.
Related Terms
- Credit Entry: An entry made on the right-hand side of an individual’s or company’s account in double-entry bookkeeping, reflecting sales or liabilities.
- Credit Limit: The maximum amount of credit that a financial institution extends to a client or organization.
- Credit Score: A statistical number that evaluates a consumer’s creditworthiness, helping lenders assess the risk of extending credit.
- Double-Entry Bookkeeping: A system of accounting in which every entry to an account requires a corresponding and opposite entry to a different account, ensuring balanced ledgers.
- Accounts Receivable: Money owed to a company by its customers, typically arising from sales on account.
Online References
- Investopedia - Credit
- The Balance - What is Credit
- MyFICO - Understanding Your Credit
- Corporate Finance Institute - Credit
Suggested Books for Further Studies
- “Credit Management: Principles and Practices” by Glen Bullivant
- “The Credit Bible: The Ultimate Guide to Money and Credit” by Day Snoap
- “Consumer Credit Law and Practice - A Guide” by Dennis Rosenthal
- “The Basics of Public Budgeting and Financial Management” by Charles E. Menifield
Accounting Basics: “Credit” Fundamentals Quiz
### What is a typical attribute a credit score measures?
- [ ] Wealth
- [ ] Age
- [x] Creditworthiness
- [ ] Annual income
> **Explanation:** A credit score is designed to measure an individual's creditworthiness, which indicates how likely they are to repay borrowed funds.
### How does a credit entry typically impact a company's financial statements?
- [ ] It decreases liabilities.
- [ ] It decreases equity.
- [x] It increases liabilities or revenue.
- [ ] It increases assets.
> **Explanation:** In double-entry bookkeeping, a credit entry typically increases liabilities or revenue and decreases assets or expenses.
### What is trade credit?
- [ ] A loan provided by a bank.
- [ ] Cash payment before delivery.
- [x] Credit extended by suppliers to buyers.
- [ ] Investment from venture capitalists.
> **Explanation:** Trade credit is an agreement where suppliers allow buyers to purchase goods or services and pay for them later.
### What influences the credit limit set by financial institutions?
- [x] Creditworthiness of the borrower.
- [ ] Number of dependents.
- [ ] Number of credit cards.
- [ ] Personal savings.
> **Explanation:** Financial institutions set credit limits based on the borrower's creditworthiness, which involves their credit score and review of financial history.
### How does consumer credit stimulate economic growth?
- [ ] It reduces consumer debt.
- [ ] It encourages saving.
- [x] It boosts purchasing power.
- [ ] It lowers taxes.
> **Explanation:** Consumer credit allows individuals to buy goods and services even without immediate funds, thus stimulating overall economic activity and growth.
### What happens during a credit sale in double-entry bookkeeping?
- [ ] A debit is made to revenue and a credit to expense.
- [x] A debit is made to accounts receivable and a credit to sales.
- [ ] A debit is made to cash and a credit to sales.
- [ ] A debit is made to inventory and a credit to cash.
> **Explanation:** During a credit sale, accounts receivable is debited, increasing the amount owed by customers, and sales revenue is credited.
### Which of the following is NOT an example of consumer credit?
- [x] House mortgage
- [ ] Credit card purchase
- [ ] Personal loan
- [ ] Payday loan
> **Explanation:** A house mortgage is typically considered a form of long-term financing rather than consumer credit, which is based on short-term borrowing scenarios.
### Who benefits from trade credit?
- [ ] Suppliers only
- [ ] Customers only
- [x] Both suppliers and customers
- [ ] Financial institutions only
> **Explanation:** Trade credit benefits both suppliers and customers by improving cash flow for the customer and generating potential sales and customer loyalty for the supplier.
### What does a credit entry signify in a liability account?
- [ ] Increase in asset
- [x] Increase in liability
- [ ] Decrease in revenue
- [ ] Decrease in equity
> **Explanation:** In liability accounts, a credit entry signifies an increase in the company's obligations or liabilities.
### Why is a sound creditworthiness important for individuals?
- [ ] To reduce employment opportunities
- [ ] To increase interest rates on loans
- [ ] To have fewer banking options
- [x] To qualify for loans with favorable terms
> **Explanation:** Strong creditworthiness helps individuals to qualify for loans at more favorable rates and terms, thus reducing the cost of borrowing.
Thank you for delving into our detailed explanations and attempting the quiz. Keep enhancing your financial acumen!
