Source of Short Term Finance and Examples
A business that borrows money to meet short-term demands or immediate expenses, usually for a duration of less than a year, is said to be engaging in short-term finance. Small companies and large corporations alike frequently need short-term finance to cover unforeseen costs, buy merchandise, pay payments, and manage cash flow gaps. Companies can meet their daily business demands without taking on long-term debt by using short-term finance. The primary sources of short-term funding will be discussed in this blog, along with instances of how companies have used them.
1. Overdrafts
Banks offer a feature called an overdraft that lets companies take out more money than they have in their accounts, up to a predetermined amount. When needed, this type of credit offers immediate access to money.
How it works: A firm can use the overdraft to pay its bills if its bank account is low or negative. Typically, interest is only assessed on the loan balance.
Example: Due to late payments from clients, a small business experiences a brief cash shortage. Payroll and supplier payments are covered by its overdraft facility until consumer payments are received.
2. Trade Credit
An arrangement that allows a company to purchase goods or services on credit and pay for them later is known as trade credit. One of the most popular forms of short-term funding, it is particularly helpful for businesses that want supplies or inventory but wish to postpone payment.
How it works: The supplier usually gives credit conditions like "30 days net" or "60 days net," which require the company to pay the provider within that time limit.
Example: A wholesaler sells $10,000 worth of stock to a store. The wholesaler consents to give the store 30 days to pay for the merchandise. This allows the retailer to make money and sell the products before they have to pay for them.
3. Short-Term Loans
Loans with a short payback period—typically less than a year—are known as short-term loans. These loans are available from internet lenders, banks, and other financial institutions.
How it works: The company agrees to pay back the loan, usually in monthly installments, over a predetermined period of time after receiving a lump sum payment from a lender. Depending on the lender and the company's creditworthiness, short-term loan interest rates can change.
Example: To buy raw materials for a future project, a manufacturing company takes out a $50,000 short-term loan. Once the project starts making money, the loan is paid back in six months.
4. Invoice Financing (Factoring)
Factoring, another name for invoice financing, is the practice of a company selling its unpaid bills to a third-party lender (a factor) in return for quick cash. The factor receives payment from the clients and advances a percentage of the invoice amount up front. The remaining amount (less a fee) is given to the company after the customer makes payment.
How it works: A factoring company purchases the company's outstanding bills and promptly advances up to 90% of the invoice amount. The business gets the remaining amount, less the factoring fee, when the consumer pays the invoice.
For instance, a wholesale supplier needs money right once to buy more merchandise even if they have $100,000 in unpaid receivables. For $90,000, the supplier sells the bills to a factoring firm, which receives the money right away while the factoring company is paid by the clients.
5. Business Credit Cards
One popular and easily available form of short-term funding is business credit cards. Businesses can use these cards to make credit purchases, and the remaining amount is usually payable in 30 days. Although interest is assessed on outstanding amounts, the business can carry a balance from month to month with the revolving credit line that the credit card provider typically gives.
How it works: Companies can use the card to pay for routine costs like marketing, travel, and office supplies. The company does not have to pay interest as long as the remaining amount is paid off each month.
Example: To cover conference travel costs, a small business owner utilizes a business credit card. To prevent interest charges, the remaining amount is paid off by the deadline.
6. Lines of Credit
A line of credit is an adaptable loan agreement that permits a company to borrow up to a specified amount from a lender. The company only pays interest on the money it uses, and it can take out from this line as needed.
How it works: A certain credit limit is granted to a business. The company can take money out of the line as needed and pay back the loan over time. The credit can be used again after it has been paid back.
Example: A $100,000 line of credit is granted to a tech business. To pay for unforeseen operating expenses like software upgrades, it takes out a $20,000 loan. The startup pays back the $20,000 after making money and re-uses the line of credit as needed.
7. Trade Finance
The term "trade finance" describes a range of financial products and instruments that assist companies in reducing the risks involved in importing and exporting goods. Trade credit insurance, documentary collections, and letters of credit are examples of short-term funding possibilities.
How it operates: International transactions are facilitated by trade finance products. A letter of credit, for instance, ensures that a supplier will be compensated for items sent, while trade credit insurance shields companies against the risk of nonpayment.
Example: An U.S. based electronics importer utilizes a letter of credit to guarantee payment to the Japanese supplier when the items are sent. Both parties are given security by the letter of credit, which also guarantees a seamless transaction.
8. Peer-to-Peer (P2P) Lending
Peer-to-peer lending is taking out loans from private investors via an internet marketplace. The interest rates are normally lower than those of regular loans, and the business usually repays the loan within a brief period of time.
How it works: Individual investors lend the money once a firm asks for a loan on a peer-to-peer lending platform. Investors get interest payments as the company gradually repays the loan.
Example: A P2P lending network is used by a small local firm that needs $25,000 to buy inventory. The platform's investors provide the company with the necessary funding, which it repays over a 12-month period with interest.
Conclusion
In order for businesses to manage cash flow gaps, pay for operating expenses, and satisfy their urgent financial needs, short-term financing is crucial. Businesses can obtain the capital they require in a number of ways, including business credit cards, invoice finance, trade credit, and overdrafts. The particular requirements of the company, the cost of borrowing, and the terms of repayment all play a role in selecting the best short-term financing source. Effective use of these choices can help organizations avoid taking on long-term debt by preserving liquidity and ensuring smooth operations.