Short-term finance is used to cover fluctuations in cash flow. Some of the short-term financial sources are as follows: Bank loans – bank loans are amount of money which is being borrowed and agreed to pay back during a certain periods of time with repayment schedule. The repayment will be decided on the amount of money borrowed, duration of the loan and the interest rates which the bank charges. Loans are generally used for assets such as machinery and buildings or to start up a new business.
Repayment periods 1 year or over which can be 5-10 years at the most. An advantage of bank loan is that some businesses may able to negotiate and obtain a repayment holiday which means that the business only pays back interest for certain amount of time and during that period of time the repayments on capital are stationary. The business does have to pay the interest but they do not have to give a percentage of their profit to the bank. There are many banks which offer loans so a business may easily be able to find the loan which is suitable for them as bank are being competitive.
Overdraft facilities – bank overdraft is a common source of short-term finance. It is the right to be able to withdraw funds you do not currently have. It allows a business to spend more than the money they have in their account. The business has the option to use the bank's money till the agreed limit and go overdrawn. Bank overdrafts are very flexible and the interest rate only takes place when a business goes overdrawn. There is a competition in the interest rates but if a business exceeds its overdraft limit the rates can be very high.
Trade-credit – this is when a firm sells goods to a customer with an agreement of billing them later. The business will try to obtain some stock from its suppliers and decide to pay after a certain date. The supplier will give a time of period to the business to pay for the stock. The time will be given regarding how well the business is doing, how the sales of the business are, how long the business is being trading with the supplier and the payment records. It is interest free for trade credit but businesses may be charged for late payments. Trade credit facility may not be available for new, small and risky businesses because as they may not be able to pay back. Trade Credit helps to ease cash flow and it is usually paid back in 28-90 days.
Factoring – the sale of debt to a specialist firm who secures payment and charges a commission for the service. Simply the business decides to sell their debtors to a factoring company and by this way the business does not wait for the customer to pay them. Instead the factoring company usually pays around %80 and the final %20 with deductions of factoring company will be received when they receive the debt.
Retailers will not use factoring because they do not have debtors, this means that in appears when there is business-to-business trading. It may be expensive to use factoring so it is actually suitable for businesses with high profit margin. Factoring companies may only buy debtors after they have checked the businesses credit history and decided that they are likely to get paid.
Leasing – provides the opportunity of renting an asset. This is similar to renting. If a business cannot afford to buy assets such as property, machinery or vehicles outright then they may decide to lease. This is also a good way of acquiring such resources as they may be needed for only short period of time. Leasing company also covers the maintenance and repair costs. If the leasing is for long periods of time this may be expensive for the business. There are different types of leasing and most common types of leasing are Operating Lease and Finance Lease.
Operating Lease – this is when the business pays for the use of the asset for particular period of time and then the asset is returned to the leasing company. Finance Lease – this takes place when the business leases the equipment and at the end of leasing they may have the option of purchasing the equipment.
Leasing is a main source of finance and by leasing a company can obtain assets to keep the business operating and keep their cash flow tight. There are some advantages of leasing. A business can save money by leasing because they do not have to pay full amount for the asset and it is only paid for a fixed period of time. Interest rates are also fixed for leasing this will ease the cash flow of the business and they will know how much they will need to pay each month. If a business prefers they may pay over a long period of time which will also ease the cash flow and they may match the payments to their income.