THE SHORT TERM SOURCE OF FINANCE

Short term capital requirements should be financed as much as possible by short term borrowing of the kind made available principally by the bank in the form of loans or overdrafts. Compared with other methods of borrowing, this method is flexible in that when the debt is no longer required, it can be quickly and easily reduced. It is also comparatively cheap because the risk to the lender is less; also, the interest charges are lower on short term than on long term loans and all loan interest is a tax deductible expense.

Source

The rigid cash and liquidity ratios that bankers are obliged to maintain will impose limits on the amount they can lend. These limits mean that the banks issue overdraft with the right to call them at short notice. If the money is recalled, the company has to be able to repay, which would be ackward if the funds had been used to purchase fixed assets. The company might have to sell assets if it had obtained the loan for long term use. Banks prefer self liquidating loans - those likely to be repaid automatically and reasonably quickly. These might include cash to finance a specific contract that will eventually result in a cash inflow for the company or a loan to a trading company for the purchase of goods or commodities which could be offered as security.

Trade Credit;

Trade credit is one of the most important forms of short term finance in the economy. Trade credit is extended by one company to another on the purchase and sale of goods and equipment.

Factoring

Factoring involves the raising of funds on the security of the company's debt so that cash is received earlier than if the company waited for the debtors to pay. Factors usually offer their clients a number of services sales credit accounting, the collection of debts, credit insurance as well as provision of finance. It is advisable for companies in need of funds to try the banks as factoring is usually costly. However, companies turn to factoring during credit squeeze.

Invoice discounting

This is an arrangement which improves the liquidity position of the user. It is designed to overcome the problem of tying up working capital in book debts. A company can convert an invoice into cash by discounting the invoice through specialised finance companies. The company makes an offer to the finance house by sending it the respective invoices, and agreeing to guarantee payment of any debt that are purchased. The cost of this service depends upon the risks and administrative costs involved. It includes an interest charge at a similar rate to those for bank overdraft plus a service charge, normally 12% - 34% of the value of the invoice