Sources of Short Term Finance

Posted by mbalectures | Posted in Introduction to Finance | 5,429 views | Posted on 22-01-2011 | Print This Post

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Organizations require finance for short-term, medium-term and long-term depending upon the nature of business. Therefore, in order to meet these requirements, funds are needed to be raised from various sources. Organizations can collect money through issuance of  shares or debentures (long term financing) or they can arrange the funds through trade credit, cash credit, overdraft, discounting of bills etc (short term financing). Short-term finance or capital is required normally for less than one year or short period. The main sources of short term finance in case of a firm are described below:

 

Advances from Customers

 

One of the main sources of short term finance is advances from customers. Advances from customers also act as source of other various factors such as: elasticity of demand, type of goods and credit worthiness of suppliers etc.

 

Trade Credit

 

Trade credit is a combination whereby suppliers of components, raw materials, finished goods, stores and spares parts, allow the customers to pay their outstanding within the given credit period. Normally, suppliers allow credit for a time of 3 to 6 months and they also provide short term finance to facilitate the current assets. The availability of trade credit depends upon enormous factors such as: status of firm, size and nature of the firm, prevailing economic conditions, policy of trade suppliers, activity level of a firm etc. It may be allowed in the shape of open account of bills payable. The major limitation of this credit is the loss of cash discount that can be earned if a payment is given with in 7 to 10 days from the purchased date. This loss is termed as the cost of this credit. Initial cost of credit may be borne by suppliers themselves, but in long term they try to shift it to the buyers in terms of increased prices which depend upon the elasticity of demand and type of goods. In such situation buyer look for alternate sources to avoid such costs imposed by suppliers. There is no explicit cost if these buyers pay the credit bills within agreed credit time.

 

Discounting Bills of Exchange

 

Suppliers usually draw exchange bill upon customers, when goods sell on credit. Time duration for such bills may be 3 to 6 months; instead of keeping the bills till the maturity date, firms prefer to get discount from bank. Discounting bills refers to an act of selling such bills to receive amount for it before maturity. Charges of bank discount with interest for the unexpired duration of the bill will be credited from the net proceeds customers’ account. On the maturity time, bank presents the bill before the acceptor of it for the payment and receives entire amount of bill. It will be dishonor of bill if bank will not receive the amount from acceptor. Bank returns dishonored bill to a firm and debits it to the account of firm.

 

Cash Credit

 

Cash credit is an agreement where bank allows borrower to withdraw money with in a specified limit from time to time. This facility is granted against the hypothecation of stock or pledge of marketable instruments or personal security. During the time of credit, borrower can withdraw, repay and again withdraw money with in the sanctioned limit. Interest is charged on the actual amount withdrawn with in actual time of use and cost of raising finance is the interest charged by bank. Advantage of this financing mode is that payment is adjusted according to the requirements of finance.

 

Bank Overdraft

 

It is also agreement, where bank permits the customer to overdraw money from its current account within agreed limit. This facility is granted against the personal securities or securities of assets. Interest is also charged on the payment actually withdrawn within actual time of use. The cost in this method is the interest charged.

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