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Solution
Abstract
In this project, an evaluation of the determinants of trade credit has been pursued. By focusing on Saudi Basic Industries Corporation (SABIC) in Saudi Arabia which is a Non-Financial Sector Company. The organisation operates in the entire GCC region and also internationally, relevant insights have been obtained. The analysis focuses on 5 years financial statements in 2018 to 2022. From the reviewed literature, by referencing on different theories of trade credit, it has been identified as separation of delivery of goods and services and payments to their suppliers. The theories which have been used in the current project include the financial advantage theory, price discrimination theory and transaction costs theory. The outcomes from the critical analysis of these theories evidence that the factors which influence scope of trade credit is prioritised to be in macroeconomic and firm-specific factors. It is normally a practice past the scope of an understanding of an organisation in being in a capacity for controlling the macroeconomic factors. It is this rationale that the determinants of trade credit have been put into consideration in the current research.
For the financial statements (2018-2022) obtained, the analysis was pursued by the application of descriptive statistics for all the variables and correlation matrix. From the analysis, there has been identified as existence of a direct correlation of determinants of trade credit and profitability. The descriptive statistics evidenced that with more credit being offered to clients, this is a strategy of an organisation to market themselves for increasing their sales and building long-term relations with their clients. For example, in SABIC case, they are used in financing of suppliers owing to the good reputation established and large economy of scale. Also, the findings evidenced that with trade credit increasing, it is possible to increase the overall sales hence offsetting high profit margin. The contrary is also true is the organisations which have high-level turnover (low product quality) provide few credit since they have worry of losing trade credit sales after pursuing an overall product quality assessment.
1.0 Introduction
1.1 Background of Trade Credit Concept
In the modern business environment characterised with high-level uncertainties and competitiveness, identifying determinants of trade credit is instrumental (Chandio et al., 2021). The rationale of this is that the concept of trade credit is critical as an area of corporate finance. In order to appropriately establish the determinants of trade credit, this is done by putting into account of the Accounts Receivable (AR) and the Accounts Payable (AP) (Kim, 2016). Despite the importance of determinants of trade credit, in the GCC region it has not attracted substantial focus in the area of corporate finance. A major reason for this trend could be an attribute of the view that determinants of trade credit are anchored on an organisation distribution activity. As evidenced in Tang and Moro (2020), with trade credit being similar to the other short-term external finance, it is important for establishing the scope of an organisation operations and profitability.
1.2 Summary of the Selected Organisation
In this project, the organisation of focus is SABIC organisation. The organisation is a global diversified chemicals company operating in Riyadh Saudi Arabia (SABIC, 2024). The organisation is involved in manufacturing global scale in GCC region and internationally. It is involved in the manufacturing of different products types which are chemicals, commodity and high performance plastic and Agri-nutrients. The organisation is involved in support of their clients through identification and development opportunities in mobility, hygiene & healthcare, electrical and electronics, packaging, agriculture and building and construction. In year 2023, the organisation had recorded a net income of approximately SAR 1.3 billion (US$ 0.35 Billion). The overall sales revenues in year 2023 was approximately SAR 141.5 billion (US$37.7 Billion). This is with their overall assets being SAR 294.4 Billion (US$78.5 Billion) as at the end of year 2023. In overall, they had a production capacity in 2023 of approximately 53.2 million metric tons.
Hence, this project relies on the financial statements of this organisation to pursue a research on the major determinants of trade credit. This is with the organisation being a popular organisation in the GCC region and entire Middle East. From the analysis, it will be evidenced that the major determinants of trade credit as including and not limited to cash held, current assets and short-term based debt. Also, by using the organisation data, an evaluation of positive relationships of the trade credit with profitability has been put into account and pursued. The data has been sourced from financial statements of SABIC in 2018 to 2022.
1.3 Rationale of this Project
In order to appreciate the rationale of this project, it is appropriate to answer the question “Why do firms extend or use the trade credit in their operations?” For the available research works, they have provided varying insights on the determinants of the trade credit. For these studies, they have integrated the financial and non-financial evidences. Focusing on the non-financial benefits of understanding the determinants of trade credit are a development of price discrimination. According to Hardy and Saffie (2023) this is by acting as a warranty for product quality and persistence of long-term, based relations with clients. This is different from the financial factors which are noted to be informed by costs, monitoring strategies and informational advantages over banks. Hence, past research works have pursued an empirical examination of the determinants of trade credit by prioritising on preference and expectations of suppliers and buyers (Pattnaik et al., 2020). There are equally a set of research works which have focused on pursuing an empirical examination of determinants of trade credit through a focus on preference and expectation of suppliers and buyers. The outcome of this included the view that for the organisation with a high-level likelihood of being constrained in their finances, they depend on the trade credit channel significantly for financing their growth process.
1.4 Project Aims and Objectives
The main aim of this project is to evaluate the determinants of trade credit. This is by focusing on SABIC which is a non-financial organisation in GCC. This is informed by the position of the GCC region where trade credit represent a significant source of their finances. In order to achieve this aim, the following objectives would be pursued;
- To current out a literature review on determinants of trade credit
- To conduct an analysis of trade credit for SABIC in 2018-2022
- To use the reviewed literature to understand the main determinants of trade credit
- To conduct descriptive statistics and correlation matrix analysis for evaluating the relationship of determinants of trade credit in SABIC and profitability
The outcomes of these objectives would lead to an increased growth of literature in the area of corporate trade credit strategies. By application of SABIC financial statements of 5 years, it would be appropriately to understand the main determinants of trade credit and as such adopt them in evaluating the profitability and performance of the organisation. The GCC region having limited literature pursued for the organisations in this sector would increase the available literature in this region. This is for guiding decision making which are holistic and improving their overall performance.
1.5 Structure of this Project
Apart from the introduction section of this project, it also include a review of literature. This is in the underlying theories on trade credit, results on the past studies on trade credit and major challenges/limitations which are supposed to be put into account in the future. Also, the collected data has also been provided in this report. This is from SABIC company which is a public listed non-financial company in GCC. The data has been analysed to generate appropriate findings and discussions. This on the main determinants of trade credit and the relationship between the trade credit and profitability. Finaly, conclusions for this report has been generated which sums up all the other sections of this project.
2.0 Review of Literature
In this section, a review of literature has been generated in the area of determinants of trade credit. In particular, in order to achieve the focus of the literature review section, the underlying theories on trade credit have been evaluated, past research works on trade credit and major challenges/limitations required to be addressed in the future. Importantly, the reviewed literature in this section has been used in later stages of this project to evaluate the relevance of the main determinants of trade credit.
2.1 Underlying theories on trade credit
2.1.1 Finance Advantage Theory
This theory is based on the assumption that organisations which have external financing challenges have their preference on trade credit. According to Chandio et al. (2020) report on Pakistan-based organisations on trade credit management, the findings evidenced that the high financial constraints organisations are found to be using the trade credit at a higher rates. This is with the suppliers having a set of advantages in offering trade credit as opposed to the financing institutions. Therefore, in line with this theory, Naseer and Siddiqui (2021) note that suppliers are well positioned in evaluation the buyer’s financial performance and their creditworthiness in their business strategy. The outcome of this is existence of lower risk of granting trade credit as opposed to the bank credit. Also, the suppliers are identified as possessing high-level powers in enforcement of repayment through threatening of the buyers towards reduction of their future supply of goods and services particularly in the market of less competition. In this regard, the preference of the buyers is substantially depending on the less suppliers. To support the importance of the theory in linking the relevance of trade credit, Bose et al. (2021) hypothesised that there are occurrences where the financial institution could be restricted by bankruptcy law. As evidenced in the research, the strength of this is that the suppliers are offered with an opportunity of offering more trade credit past the set amount which are to be provided by these banks. Despite the potential of a negative reputation, there is equally an instance where the suppliers could repossess the goods when the buyers fails in realising the payments with the goods resold to other prospective customers. Hence, the key findings in the theory is that the trade credit is determined by the scope in which a buyer can be trusted in terms of creditworthy and capacity of sourcing other lower costs through external-based financing. The main assumption is that organisations readily accessing capital markets would have a potential of extending more trade credit to those lacking the arrangement.
Despite of the strengths of the theory in establishing the determinants of trade credit, there are equally a set of disadvantages. For example, Kim et al. (2020) argued that there is a common belief only bank has a potential of assessing borrowers creditworthiness when cross-checked with the suppliers. Also, it is not clear on the rationale of the suppliers failing to provide lending to the borrowers despite having detailed financial information with their preference being offering value of inputs as trade credit.
2.1.2 Price Discrimination Theory
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