Types / Sources of Credit and the impact of Credit within the Economy

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Level: AS Levels, A Level, GCSE – Exam Boards: Edexcel, AQA, OCR, WJEC, IB, Eduqas – Economics Revision Notes

This involves borrowing money which is then repaid at a later date with added interest payments
Secured Loans – these are secured against the borrower’s assets to protect the bank’s funds if the loan cannot be repaid back
Loans can be in the form of: cash credit, on demand, or only for short term
Cash Credit Loans – these are based on bonds and other securities
Loans on Demand – entire loan is paid into the borrower’s account and is charged with interest immediately
Short Term Loans – usually secured against a security and tend to be personal or for working capital
Loans can be inflexible and if less money is needed than the amount borrowed, interest still has to be paid on the full amount
Some interest is fixed so firms know exactly how much interest they will have to pay

Overdrafts allow a consumer / firm to borrow temporarily from the bank by spending more than what is saved in the account
The amount which can be borrowed is limited and the interest rates are usually quite high
Interest is only paid on the amount borrowed and the amount borrowed is flexible

The credit which is extended to a firm by suppliers, meaning a good can be purchased and paid for at a later date
Small firms can benefit when financing their growth
Sellers are able to generate more sales by enforcing a Trade Credit system – however if the buyer takes a long time to pay the supplier back – it can lead to lower profits
Trade Credit is a fast source of income

Commercial banks generate a large proportion of their income through interest payments on loans they issue
Banks use deposited funds as loans to create credit
Firms’ main source of credit is from commercial and high street banks

Specialist firms receive a share in a company in return for the funding they provide to the firm – this aims to help new firms establish themselves
Investor receives dividends – a return on the investment

Selling shares to investors will raise the share capital and is applicable to both public, as well as private companies
Shareholders get to input their opinions on how the company should be run and receive a dividend as a reward for investing into the firm

This is a long term agreement that allows firms to use an asset without having to pay the full amount upfront
The firm can own / control the asset and pays rent to cover the depreciation of the asset. They also pay interest to cover the cost of the capital

This refers to the amount of money that an owner has available to invest into the firm and saves them from borrowing expensive credit from a bank
There are no costs involved in obtaining the capital since the owners already own the capital
Interest on a loan does not need to be paid and dividends do not need to be shared with shareholders
However, if capital is lost, the owner also loses it

This is the money remaining after deducting taxes, interest, and dividend payments from the total sales revenue
Firms may choose to reinvest their retained profit into the company as they are a cheap source of finance
Retained profit does not increase a firm’s debt as they are not borrowing additional money and owners have more control as third parties are not involved

A firm can sell its assets to raise money and could lease assets instead
The money gained from selling the asset could act as an immediate source of finance – useful in the short run
Selling assets can also reduce the costs involved with maintaining capital
However, depending on market circumstances, firms may have to accept a lower price for their asset

Investors can help finance the business
However, conflict between different shareholders may occur
Risk is shared between the shareholders who invest in the firm – this also means the profit it distributed

Crowd Funding – useful for new firms who are struggling with gaining access to credit from a bank
This involves using the internet to aid raising funds from several people – known as a ‘crowd’
Firms using Online Collaborative Funding can raise finance quickly and at a low cost – however, firms have to raise funds to a certain target for it to be a success
Using online funding, firms can also advertise their business to spread awareness and widen their consumer base – however, if they do not receive anything, they risk building a bad reputation

Credit allows firms to build a credit rating – new firms are likely to have a low credit rating at first – this makes it harder for them to gain access to credit from banks
Firms with a higher credit rating are likely to gain access to credit more easily and at a lower cost
Firms with a lower credit rating may experience difficult conditions when borrowing funds – such as higher interest rates on loans

Quick Fire Quiz – Knowledge Check

1. Identify and explain three types of credit (12 marks)

2. Explain how banks are a source of credit (4 marks)

3. Identify and explain four other sources of finance (15 marks)

4. Explain the role and impact of credit in the economy (4 marks)

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