Credit Definition & Meaning

KEY TAKEAWAYS

• Credit is typically defined as a contract whereby someone borrows something of value to then will repay the lender by an agreed-upon date.
• Credit can also be referred to as someone’s viability in being trusted to repay a lender within the agreed terms.
• Someone with a good history of credit can be referred to as ‘creditworthy’ or having ‘good credit’.

What Is Credit?

Although a broad term with many definitions, credit can typically be defined as a payment contract between two parties. The borrower receives something of value, to then repay the lender by an agreed-upon date. The borrower will generally be charged interest on the amount payable. 

Additionally, the more of these interactions a borrower has will affect their ‘creditworthiness’. This is also often referred to as having good/bad credit. This will help lenders or a financial advisor determine whether they can trust that the value will be paid back promptly in a report to business. This will be alongside any additional financial charges such as interest. 

How Does Credit Work?

Credit works by having an agreement with a lender. Under this agreement, you will obtain goods or services from someone else. You will then pay for these goods or services at a later date under the agreed upon terms. 

For example, if you buy goods from a trader on a weekly basis, you can open a line of credit. At the end of the month you will pay the accumulated balance. Or a simpler example is bank credit. You could have bank credit card accounts where you pay for goods with the card. You then pay the bank back at the end of the month. 

Most Popular Forms of Credit

Installment Credit

This is the most popular type of credit. It includes car loans, signature loans or mortgages. Simply put, this is when the lender credits money to a borrower. Entrusting that they will pay it back at a later date, or face legal/financial penalties. These payments are typically equal monthly installments.

In other cases, financial sources are not the only type of credit. For example, if a shop takes a bulk order and is later invoiced, the supplier is offering a type of credit. 

Revolving Credit

This is when you are given a borrowing limit. With revolving credit, you must make a minimum charge each month, and can then charge up to your credit limit. Most credit cards are a type of revolving credit. If a partial payment is made, you will then carry the remaining balance onto the following month. Alternatively, you can revolve the debt. 

Service Credit

Most service provider contracts are done via a credit agreement. Services such as gyms, internet providers, etc will provide a service to then be paid monthly in order to continue use. 

Some modern credit scoring systems will consider this when calculating your credit score.

Credit in Financial Accounting

In terms of financial accounting, a credit is an account entry. This will record the sum that is being received. 

For example, if a company were to buy merchandise on credit, the company’s inventory account would increase by the sum of the purchase. This would add an asset to the company. However, its accounts payable field (bills that are due) will then increase by the same amount, adding a liability to the company.

Summary

Credit is a great way to raise capital for your business. It is a relatively safe and reliable way to raise the money that your business needs. Just as long as you don’t have a bad credit history, or a history of bad business practices. The most important thing is to make sure you’re not taking on more debt than your business can handle.