Short-term financing deals with raising of money required for a shorter periods i.e. periods varying from a few days to one year. There are, however, no rigid rules about the term. It may sometimes exceed one year but still be called as short-term finance.
The practice of almost all European banks is to regard short-term finance up to one year. Thus, we can conclude that short-term finance may be for a very short period of one to three months or for longer periods up to one year.
All working capital except that part of it which is necessary for holding a minimum level of raw materials, stores, finished goods in an industry, is short-term capital. It should be noted that the requirements of regular or permanent working capital for the business should be financed through sources of medium and long-term finance.
The main feature of short-term finance is that it is raised and paid back within a shorter period of time.
Main Sources of Short-term Finance
The short-term financial needs of the companies are generally met from the following sources:
Account Receivable Financing.
Now we shall briefly discuss the various sources of short-term finance.
1. Trade Credit
Just as a firm grants credit to its customers it can also get credit from the manufacturers or wholesalers or suppliers. It is known as trade or mercantile credit.
According to Howard and Upton, trade credit may be defined as
the credit extended by the seller to the buyers at all levels of production and distribution processes down to the retailer.
The usual duration of this credit ranges from 30 to 90 days. It is granted to the company or firm on “Open account” without any security except that of the goodwill and financial standing of the buyer.
Trade credit does not make available the funds in cash but it facilitates the purchase of supplies without immediate payment. No interest is generally payable on trade credits. But the borrower cannot get any cash discount. The availability of the trade credit depends upon the buyer’s need for it and also the willingness of the supplier.
The willingness of the supplier to extend credit is also depending upon the following factors:
The financial resources of the supplier.
His eagerness to dispose of his stock.
Degree of competition in the market.
Credit worthiness of the firm.
2. Consumer Credit or Customer Advance
Many times the manufacturers or the suppliers insist on, advance by the customers particularly in case of special orders or big orders. The customer advance forms part of the price of the products ordered by him.
Some times, the customer also tenders the full price. This is an interest free source of finance. The period of such credit depends upon the time taken to deliver the goods. The availability of this credit also depends on the following factors:
1. Competitive conditions in the market — If acute competition prevails, the supplier cannot insist the buyer to pay an advance.
2. Customs of the trade and usage.
3. Reputation of the supplier.
3. Installment Credit
This is also called consumer credit. Retailers for selling consumer durable generally use it. Here, however, we use the term “Installment credit” to denote the facility provided by the equipment suppliers on easy installments as this serves to provide capital to a firm in kind.
Installment includes interest on unpaid sums and is suitably spread so as to enable the purchasing company to meet them out of current cash flows.
Commercial banks and financial institutions, now-a-days provide this form of credit on liberal terms. Hire purchase system is also a modified form of the installment credit. In the hire purchase system, the title over the machinery or equipment remains with the supplier until the full price amount is settled.
4. Accounts Receivable Financing
Under this method, a financing company purchases the account receivables from the customers or money is advanced on the security of the accounts receivable. In short, it is a method of getting credit by pledging book debts.
In financial accounting, it is denoted as Sundry Debtors or Trade Debtors, and this item appears on the asset side of the Balance Sheet.
Since credit sales are unavoidable in trading transactions, every trader has always a larger amount locked up in the form of Account Receivables. This account receivable is a right to property and a right to collect the amount from the client. This method of financing is very popular in the United States of America.