Types / Sources of Short-Term Financing

As we understood, why we need short-term financing, there are various sources of short-term financing for a business. Each type of short-term finance has different characteristics and can be used in different situations. Some of those are explained below:

Trade Credit

Ooh yes, you have understood it right. It is the credit extended by the accounts payables. We would classify this credit into 2 types – free trade credit and paid trade credit. After a particular no. of days as per payment terms, the supplier charges interest on the delay of payment. So, the period before this is free trade credit and after that is paid trade credit.

It’s quite obvious that the free trade credit should be as much as possible because it is free of cost. How much is free trade credit extended to a customer? It depends upon the creditworthiness of the buyer, discipline maintained in payment commitments, the bulk of the business, etc. Higher you rate on these factors, higher would be the free trade credit available to your business.

Paid trade credit is definitely a type of short-term financing but on the priority list, it would be quite below. In short, it should be selected only when another financing is not available. The reason for not opting for it is its high-interest cost.

Short-term / Working Capital Loans

Short term loans can be availed from banks and other financial institutions. Banks extend these loans after careful study of the business, its working capital cycle, past track record etc. Once availed, these loans are repaid either in small installments or may be paid in full at the end of the period. This depends on the terms of the loan. It is advisable to use these loans for financing permanent working capital needs. There are other alternatives to fund the temporary working capital needs. For more refer Working Capital Loans.

Business Line of Credit

Business line of credit, a type of short term financing, is most appropriate for termporary working capital needs. In this type of financing, an amount is approved by the issuing bank or financial institution. Within the limit of this amount, the business can make payment and keep depositing once payment from customers is received. It works like a revolving credit and best part of this is the interest is charged on the utilized amount only and not on the approved amount. The business has the flexibility to deposit unused amount to save on interest cost. This way it becomes a very cost-effective financing option.

Invoice Discounting

Invoice discounting is another source of short-term finance where the receivable invoices can be discounted with the financial institutes or banks or any third party.  Discounting invoices means the bank will pay you the money at the time of discounting and collects the money from your customer when the bill becomes due.

Detailed post: Invoice Discounting

Factoring

Factoring is also a similar arrangement like invoice discounting where the accounts receivables of a business are sold to a third party at a price which is lower to the realizable value of the accounts receivable. This purchasing party is commonly known as a factor. These factoring services are provided by both banks and other financial institutions. There are many types of factoring like with recourse or without recourse etc.

Short-Term vs Long-Term Financing

The most important difference between the two types of financing is the time period, the purpose and the cost of financing. The time period is simple to understand. Short-term financing is normally for less than a  year and long-term could even be for 10, 15 or even 20 years. The purposes are totally different for both types of financing. Short-term financing is normally used to support the working capital gap of a business whereas the long term is required to finance big projects, PPE, etc. The third thing is the cost of financing which is higher in case of short-term and comparatively lower in case of long-term barring abnormal economic conditions.

Last updated on : March 3rd, 2018
What’s your view on this? Share it in comments below.

About The Author

Sanjay Bulaki Borad
Sanjay Bulaki Borad

Sanjay Borad is the founder & CEO of training100.ru. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".

Leave a Reply

Factoring Vs. Discounting
  • Types of Invoice/Receivable Factoring
    Types of Invoice / Receivable Factoring
  • Advance and Maturity Factoring
    Advance and Maturity Factoring
  • Buy Vs Lease
    Buy Vs Lease
  • First Mortgage
    First Mortgage
  • Subscribe to Blog via Email

    Enter your email address to subscribe to this blog and receive notifications of new posts by email.

    Recent Posts

    Find us on Facebook


    Related pages


    what is the difference between multinational and international companiescapital rationing exampleexplanation of accounting equationcapital lease or operating leasemm approach of dividend policyexplain variable costsmeaning of discounted cash flowsales forecasting regression analysisaccelerated depreciation definitionwacc calculation exampleexport lc discountingadvantages and disadvantages of inventoryhow do i calculate inventory turnovertimes interest earned ratio analysisfavorable financial leveragedefine installment buyingvalue of callable bondbenefits of capminventory turnover measuresstockholder vs shareholdercapitalize and expensehypothecationwacc examplemarginal or variable costingpayback analysis definitionassumptions of capital structure theoriesmeaning of gdrshort term solvency ratio definitionhow to record bank overdraft in accountinghypothecation of immovable propertydefine debt covenantcapital rationingeps maximizationwhat is debits and creditsadvantages of benefit cost ratiopayback analysis definitionactivity based budgeting disadvantagesmmm dividend historycash accounting and accrual accounting differencedescribe the assumptions underlying cvp analysisdscr ratio calculationcalculate bepreturn on asset ratio analysis interpretationconcept of capital rationinginventory turnover ratio definitionrumus acid test ratioirr capital budgetingcapital structure wacccost of equity capital calculatorunsecured bank loan definitiondividend valuation model advantages and disadvantagesadr and gdrmargin of safety formula percentageinvestopedia working capitalstockholder vs shareholderadvantages and disadvantages of hire purchaseredeemable preference shareprofitability ratios listeconomic order quantity in inventory managementabc analysis advantages and disadvantagesgordon model of dividend policytobin q ratiowhat is current cash debt coverage ratiodefine debenture bondcompany debenture definitioncost of equity investopediaratio analysis and interpretationfinance ebitratios for financial statement analysisbank guarantee sbiwhat is the formula for hire purchasewhat does payback period meanbank loan covenantsaccount receivable turnover in days