SHORT TERM FINANCING
Short term financing refers to business financing from short term sources which are for lease than a year. This assists the company to generate cash for working of the business and for operating expenses which is usually for a comparatively small amount. It involves developing money by online loans, invoice financing and lines of credit.
It is also called as working capital financing and is used for inventory receivables etc. In most cases, this type of financing is required in the process of business because of seasonal business cycles and uneven cash flow into the business
KINDS OF SHORT TERM FINANCING
1. Working capital loans:
Other financial institutions and banks extend loans for a shorter duration after studying the business’s nature, records, working capital needs and cycles etc. Once the loan is sanctioned and disbursed by the financial institution or bank, it can be repaid in small instalments or pain in full at the end of loan tenure, depending on the terms agreed for loan between both the parties. It is often advised to finance the permanent working capital needs through the help of these loans.
2. Trade Credit:
This is the floating time that allows the business to pay for the commodities and services they have bought or received. The general floating time allowed to pay is 28 days. This assists the businesses to manage their cash flows more efficiently and help deal with the finances. This is a good way of financing the stocks or inventories, which implies how many days the vendor will be allowed before its payment is due. The vendor offers the trade credit as an inducement in an ongoing business, which is why the cost is nothing.
3. Business line of credit:
It is the best way of financing working capital needs. The business can approach the approval bank of a certain amount based on the credit line structure judged through a credit score, projected inflows and business model. Then, the business can withdraw the amount as and when required, subject to the maximum approved funds or amount. Further, they can again deposit the amount as and when it gets available. In addition to it, the best thing is that the charged interest on the funds utilised on the daily reducing balance method. In this way, it becomes a very cost efficient mode of financing.
4. Invoice Discounting:
It refers to arrangement of funds against submitting invoices whose payments will be shortly received. The receivable invoices are discounted with the financial institutions, banks or any third party. On the submission of bills, they will pay the discounted value of bills and on the due date, they will collect the payment on the behalf of business.
It is an identical arrangement of finance like discounting of invoices. It is debtor finance in which businesses sell their accounts receivable to a 3rd party whim we call factor at a lesser rate than the NRC. It can be of any type without recourse or with recourse.
MERITS OF SHORT TERM FINANCING
1. Less documentation:
As it is very less risky, the documents required for this will be not much making it an easy option for all to approach.
2. Less interest:
As these need to be paid off in a very short span of time within a year, the total amount of interest cost under it will be less when compared to the long tenure loans that take years to be paid off. The total interest cost of long term loans might be more than the whole principal amount.
3. Disbursed Quickly:
The default risk involved in the repayment of loan is less than that of long tenure loans as they have a prolonged maturity date. Hence it takes less time to get sanctioned to the short term borrowings as their maturity will be close. Therefore, one can get the loan sanctioned and the fund disbursed very quickly.
DEMERITS OF SHORT TERM FINANCING
The prime demerits of short term loans is that one can get a smaller loan and a shorter date of maturity so that the borrower won't get burdened with huge instalments. Hence it is fixed that the loan period will be within one year. Hence, if a high amount of borrowing is sanctioned, the monthly instalments will be very large, increasing the chance of default in repayment of the loan which affects the credit score ultimately.
It can leave the borrower into the trap of the borrowing cycle in which one continues to borrow and repay the previous unpaid loan. In this cycle, the interest rate goes up which ultimately affects the liquidity and business.