European Financial Management, Vol. 16, No. 3, 2010, 400–421 doi: 10.1111/j.1468-036X.2008.00461.x A Dynamic Approach to Accounts Receivable: a Study of Spanish SMEs Pedro J. Garc´ ıa-Teruel and Pedro Mart´ ınez-Solano Department of Management and Finance, Faculty of Economics and Business, University of Murcia, Murcia, Spain E-mail: pjteruel@um.es; pmsolano@um.es Abstract The main objective of this paper is to extend the literature on the granting of trade credit. The focus is to test whether the accounts receivable decisions follow a model of partial adjustment. To do that, we use a sample of 2,922 Spanish SMEs. Using a dynamic panel data model and employing the GMM method of estimation we control for unobservable heterogeneity and for potential endogeneity problems. The results reveal that firms have a target level of accounts receivable and take decisions in order to achieve that level. In addition, we find that sales growth (if positive), the size of the firms, their capacity to generate internal funds and get short term financing, and economic growth are important in determining trade credit granted by firms. Keywords: accounts receivable, trade credit, SMEs, partial adjustment model, endogeneity JEL classification: G31, G32 1. Introduction Trade credit is provided when there is a delay between the delivery of goods or the provision of services by a supplier and payment for them. For the seller, it represents an investment in accounts receivable. That investment represents an important proportion of a firms’ asset. Specifically, the average level of accounts receivable over assets for the Spanish firms considered in this study was 38.63%. The literature offers various theories explaining the use of trade credit based on the advantages for suppliers and for customers from the operational, commercial and financial perspective: reduction in transaction costs (Ferris, 1981; Emery, 1987); reduction in information asymmetry between buyer and seller (Smith, 1987; Long et al., 1993); a mechanism of price discrimination (Brennan et al., 1988; Petersen and Rajan, 1997); and greater access to funds for firms that have difficulty accessing This research is part of the Project ECO2008-06179/ECON, financed by the Research Agency of Spanish government. The authors also acknowledge financial support from Fundaci´ on CajaMurcia. The authors thank anonymous referees who have contributed to this paper. C  2008 The Authors Journal compilation C  2008 Blackwell Publishing Ltd