Sources of Short-Term Finance

Sources of Short-Term Finance
5
(1)

Do you know what short-term financing is and what are some of their sources?

Worry not; we are here to let you know all about this!

Let’s dive in!

Short-term financing mainly focuses on paying a business’s current liabilities and meeting the demand for current assets.

Simply put, short-term financing aids in minimizing or mitigating the gap between a company’s current liabilities and current assets. There are numerous ways to raise capital with the help of the market for a short time period. Several agencies, like cooperative banks, commercial banks, NABARD, and financial institutions, offer financial assistance to businesses.

Short-term financing can be an excellent option for companies that need some capital for their business to grow. Although short-term financing is typically thought of as a source of quick cash, it does not necessarily mean that you receive your money quickly. In fact, most lenders will demand some sort of collateral before they consider any sort of loan.

Some sources of short-term finance are as follows

  • Trade Credit
  • Accruals
  • Inter-Corporate Deposits (ICDs)
  • Commercial Banks
  • Public Deposits
  • Deferred Income
  • Commercial Paper (CPs)
  • Installment Credit.
  • Factoring

Trade Credit:

Trade credit is the credit given to a customer by a supplier of products or services during the regular course of business. It holds an indispensable place in short-term finance because of the arduous competition. Nearly all manufacturers and traders needed to expand their credit portion, without which there would be no business. Trade credit is generally an unexpected source of financing that develops in general business transactions without any particular negotiation.

If you want to get the trade credit source, the buyer must have a dependable as well as acceptable reputation and creditworthiness in the market. It is typically expanded in the form of bills of exchange or open accounts. An open account is a type of trade credit in which a supplier supplies goods to the buyer, and the payment is to be made in the future according to the terms of the sales invoice.

Advantages of Trade Credit:

  • It is easily available when compared to other sources of financing
  • It is flexible as the credit incline with the growth in sales of the firm
  • It is automatic finance.

Accruals

Accruals or Accrued expenditures are those types of expenses that the company owes to another party but which are neither yet due nor paid. Accrued expenditures represent a liability that an organization has to pay for the goods and services it has received. It is an interest-free as well as a spontaneous source of short-term financing. The pertinent components of accruals are interest and taxes, salaries, and wages. The salaries and wages are typically paid on a weekly basis and monthly basis, respectively.

Inter-Corporate Deposits (ICDs)

It is a deposit made between two firms and is referred to as an inter-corporate deposit (ICD). Typically, these deposits are often made for up to six months.

These deposits are of three types:

  • Three Months Deposits
  • Call Deposits
  • Six months Deposits

Commercial Banks

The primary source of working capital financing for businesses and commerce is commercial banking. One of their primary responsibilities is providing loans to businesses. Acquiring a bank loan is a difficult task because the lending bank may inquire about the financial situation as well as future intentions of a prospective borrower.

Simultaneously, the bank will want to keep track of the borrower’s business development. However, there is a positive side to this: borrowers’ share price tends to increase because investors are aware that persuading banks is a challenging task.

Some forms of bank financing are:

  • Loans
  • Letter of Credit
  • Cash credits
  • Overdrafts
  • Discounting of bills or Purchase

Public Deposits

Public deposits, also known as term deposits, which are in the form of unsecured deposits, are requested by firms (whether small or large) from the general public mainly to finance their working capital needs.

Regulations:

The fixed deposits by businesses are ruled by the Companies (Acceptance of Deposits) Amendment Rules, 1978.

The benefits of Public Deposits are:

  • Public deposits are issued via a simple process.
  • There are no restrictive covenants involved
  • No guarantee is provided on public deposits.
  • More affordable (post-tax cost is somehow reasonable).

Disadvantages:

  • Only a small amount of money may be generated.
  • Funds are available for a short period of time.

Deferred Income

Deferred income is a kind of income that a firm receives in advance for supplying services or goods in the future period. Moreover, the income boosts the company’s liquidity as well as serves as a significant source of short-term funding. These payments are recorded in the balance sheet as a form of income received in advance but are not shown as revenue until the delivery of products or services.

The advance payment can be requested by firms who have monopoly power, high demand for their goods & services, and if the company is producing a unique item on a particular demand.

Commercial Paper (CPs)

Commercial paper is a short-term and unsecured promissory note that is typically issued by companies with a good credit rating. It was first developed in the USA and is a crucial tool in the money market. In India, CP was introduced by the Reserve Bank of India on the suggestions of the Vaghul Working Group. Commercial Paper is a source of short-term financing only for big firms with the proper financial position.

Features of Commercial Paper

  • A CP can reach maturity in 15 to 365 days (but if we talk about India, CP ranges between 91 to 180 days).
  • It is generally redeemed at its face value but sold at a discounted face value
  • Return on Commercial Paper is the difference between redeemable value and par value
  • It may be sold, either directly to investors or indirectly via dealers
  • There is no secondary market for Commercial Paper

Benefits of Commercial Paper

  1. It serves as a backup source of funding and is beneficial when bank credit is limited.
  2. When we compare it to bank credit, it is a less expensive source of short-term financing.

Installment Credit

Another source of short-term financing is installment credit, which requires that the borrowed money is paid back with interest in equal installments. It is also known as a hire-purchase plan or an installment plan. Suppliers offer installment credit to the company with the promise that repayment would be made in a fixed amount and at regular intervals. It is mainly used to obtain long-term assets utilized in the production procedure.

Factoring

One source of working capital is factoring. In order to facilitate the free operation of lending as well as investment operations, banks have been given more comprehensive flexibility to borrow and lend money both externally and internally. Since 1994, banks have been permitted to enter direct leasing, hire purchasing, and factor services, regardless of their subsidiaries. Simply put, banks are allowed to exit and enter any realm relying on their profitability; however subject to specific RBI rules.

Nowadays, financing a business is not as difficult as many people perceive it to be. There are many sources of short-term financing that make your work easy. You also have the option of financial institutions and investors across the world that provide funding to small businesses on a short-term basis.

How useful was this post?

Click on a star to rate it!

As you found this post useful...

Follow us on social media!