Financial Friday: Credit

What Is Credit?

How do you define credit? This term has many meanings in the financial world, but credit is generally defined as a contract agreement in which a borrower receives a sum of money or something of value and repays the lender at a later date, generally with interest.

Credit also may refer to the creditworthiness or credit history of an individual or a company.1 To an accountant, it often refers to a bookkeeping entry that either decreases assets or increases liabilities and equity on a company's balance sheet.

KEY TAKEAWAYS

• Credit is generally defined as an agreement between a lender and a borrower.
• Credit also refers to an individual's or business's creditworthiness or credit history.

How Credit Works

Credit is essentially a social relation between a creditor (lender) and a borrower (debtor). The debtor promises to repay the lender, often with interest, or risk financial or legal penalties. Extending credit is a practice that goes back thousands of years, to the dawn of human civilization.

Today, a commonly used definition for credit still refers to an agreement to purchase a product or service with the express promise to pay for it later. This is known as buying on credit. The most common form of buying on credit today is via the use of credit cards. This introduces an intermediary to the credit agreement: The bank that issued the card repays the merchant in full and extends credit to the buyer, who may repay the bank over time while incurring interest charges in the meantime.

A Financial Element, similar to a literary element, refers to components of a Financial Narrative. Understanding the financial elements can help us in creating and planning Your Financial Narrative. We will continue to look at various other financial elements each week as a part of the Financial Fridays