Short Term Finance Examples
In order to have a successful business there needs to be a constant flow for any type of working capital. This is a vital component considering that outflow is going to be a part of each cycle; raw materials must be purchased; wages and salaries need to paid; equipment must be serviced; then funds are necessary for advertising, marketing and other overhead costs as well as the needed reserves until a customer makes a payment. The lifeline of any business is going to be working capital.
One of the biggest questions asked is just “how does a company get those funds for working capital?”. The answer is financing, but there are two types – long-term and short-term financing.
Short-Term Financing
Short-term financing is when a company needs finances for only a short time, which is often under a year. This may also be called financing for working capital.
This can be needed due to seasonal business patterns, cash flows that are uneven, etc. However, there are times when it will be used in order to finance accounts receivable, inventory, etc. Yet, only single orders for specific business will be financed.
Sources Types of Short-Term Finance
There is an understanding about why this type of financing is needed. There are different sources to get this type of financing for companies. Each type will have a different type of characteristic and may be used for various situations. Below some of these types discussed:
Examples of short term sources of finance
Trade Credit
This is a type of credit that will be extended by accounts payable. This can be often be split into two types which is paid and free. After a certain amount of days based on the payment terms, suppliers will charge interest for payment delays. If the period happens to be free, once it is delayed it becomes paid.
Free trade credit is what should be used as often as needed, simply due to it being free. How much can this cost? It actually depends buyer’s credit, payment history, business, etc. The higher that the rating is, then this credit will be higher.
Paid trade credit happens to be considered to be short-term, but it should only be used whenever other types of financing are not available and the reason is due to high interest costs that come with it.
Working/Short-term Capital Loans
You can get a working capital loan from a financial institution or bank. A bank will provide this type of loan after the business has been studied, and the cycle of working capital as well as the track record are looked at. Once it has been determined that it is available, then these loans will have to have payments made in small payments or it is paid in full. This will be based on loan terms. It is best that these loans only be used when there is a need permanent capital.
Line of Credit for Business
This is the form of financing that is best for temporary capital. Therefore, when you use this type, a set amount will be approved by a financial institution or bank. Inside of credit line, a business is able to make a payment and then continuously deposit once the customer payment has made their payment. It is similar to using revolving credit. This means that the interest is only for what has been used, but not on what for approved amounts. A business will be able to deposit any unused amount in order keep interest low. This is seen to be the best way to be cost effective when it comes to financing.
Invoice Discounting
This another type of financing where any received invoices are able to be discounted through banks, financial institutions or a third-party. This means that banks will pay the company when you discount the invoiced and then it will collect payment from the customer whenever the invoice is due.
Factoring
This type of financing is almost similar to discounting when an account would be sold to the bank at a lower price than the realizable value for the account. This particular type of purchase is called a factor. A person can get these services at a financial institution and bank. There are various forms of factoring that may be used as well such as recourse, non-recourse, etc.
Another great thing to know is that banks will a great source to gain working capital for short-term time periods.
Overdraft Agreements
Whenever a business goes into overdraft agreements with banks, a bank will let the company borrow up to a set amount without there being any other discussion needed. However, a bank could ask for a type of security and this could be collateral, or it could be interest with variable rates on any outstanding amount. However, if a company believes that they can repay it quickly, then overdraft agreements will be a useful tool for financing. This is a form that is often used by many businesses will go to.
Financing on Accounts Receivable
There are a lot of non-banking and banking institutions that will provide a way to provide financing to any accounts receivable. This means that the institution will purchase the bill and then collect amounts from customers. A company that has large credit terms can continue doing business and not needing to wait to get full payment from a customer.
Customer Advances
Many businesses that state you have to pay before any services are provided or goods are sold. This is a good thing, especially if it is a large order that could take a bit to fulfill. This also helps to make sure that there are funds that can be channeled into operations while the orders are being taken care of.
Installments
Some businesses, especially the ones that sell home appliances like stoves, refrigerators, televisions; businesses that sell electronics like computers, radios, etc., and the ones that sell cars may allow a customer to pay off their bill in installments. Because most items are something that is now considered to be an essential, the customer may not be from a wealthy background and be able to afford an upfront cost. If that is the case, then there is no need to wait for large lump sums, the business will let the customer make small monthly payments until it is paid off. This helps to make sure that there are regular funds coming in and it is not choking up accounts receivable.
Long-term Financing
One thing that many business owners need to know is that when a company relies on short-term amounts to be able to the needs of working capital, it will not always be the best thing, especially for an industry where it actually manufactures the product, which takes a bit of time to do like refrigerators, vehicles, computers, and aircrafts. These companies are the ones that need to have working capital that will be able to be used for extended periods of time, and so they are the ones that often lean towards long term financing.
Long-term Loans
There are some businesses that will just decide that they rather get a bank loan with long-term repayment options. This will allow the company to have working capital that will be needed for at least 3 years or more.
Retain Profits
Instead of a business providing shareholders with dividend payments or even investing in something new, there are some companies that will retain a certain amount of the profits that they make so that it can be used to create working capital. The businesses do this so that there is nothing to worry about taking out a loan, paying interest, taking a loss for discounted invoices, and they are able to be self-sufficient when it comes to the financing of the company.
Debentures and Issue Equities
There are going to be some cases when a company is extremely low on funds, or whenever a business decides to invest in a new venture to expand, the business could decide that they are going to issue bonds or debentures to the public, then there are cases where they could issue equity stock. This is only done by large conglomerates and it is only really used whenever a necessity for a lot of funds at one time is required.
A company cannot always rely on certain limited sources in order to get working capital. Multiple options need to be used and the needs of the company will always need to be evaluated. This can be done using an analysis of financial ratios and financial statements. The channel where working capital comes from needs to be selected carefully as it will be an ongoing process. Different types are various points in time may be more appropriate. The whole thing is for a company to select the right type of alternative based on the situation that they may have at that particular moment in time. Hopefully, this guide shines a light on what can be done by a company when it comes to meeting the needs of working capital.
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