Methods of Raising Short-term Finance

There are a number of methods used for raising short-term finance. These are:

1. Trade Credit

Trade credit refers to credit granted to manufacturers and traders by the suppliers of raw material, finished goods, components, etc. Usually business enterprises buy goods on 30 to 90 days credit. This means that the goods are delivered but payments are not made until the expiry of the period of credit.

This type of credit does not make the funds available in cash but it facilitates purchases without making immediate payment which amounts to funding it by suppliers. This is a very popular source of short term finance.

2. Bank Credit

Commercial banks usually provide short-term finance to business firms, which is known as bank credit. When bank credit is granted, the borrower gets a right to draw the amount of credit as and when needed. Bank credit may be granted in any of the following ways:

  1. Loans and Advances: When a certain amount of money is advanced by a bank repayable after a specified period, it is known as bank loan. Such advance is credited to a separate loan account and the borrower has to pay interest on the whole amount of loan irrespective of the amount of loan actually drawn. Usually loans are granted against security of assets.

  2. Cash Credit: It is an arrangement whereby banks allow the borrower to withdraw money up to a specified limit. This limit is known as cash credit limit. This facility is granted against the security of goods in stock or promissory notes or other marketable securities like government bonds. Under this arrangement, the borrower can draw, repay and again draw the amount within the sanctioned limit. Interest is charged only on the amount actually withdrawn and not on the amount of entire limit.

  3. Bank Overdraft: When a bank allows its depositors or account holders to withdraw money in excess of the balance in his current deposit account up to a specified limit, it is known as overdraft facility. This limit is granted purely on the basis of credit-worthiness of the borrower. Interest is charged only on the overdrawn money. Rate of interest in case of bank overdraft is less than the rate charged under cash credit.

  4. Discounting of Bill: Banks also give advance money by discounting bill of exchange. When a bill of exchange is presented before the bank for encashment, bank credits the amount to customer’s account after deducting some discount. The amount of discount is charged on the basis of the interest for the period of bill. On maturity of the bill, the payment is received by the bank from the drawee.

3. Factoring

Factoring is a method of raising short-term finance for the business in which the business can take advance money from the bank against the amount to be realised from the debtors. By this method, the firm shifts the responsibility of collecting the outstanding amount from the debtors on payment of a specified charge.

Here the business gets the money in advance without waiting for due date. Also, it saves the effort of collecting the debts.

4. Customers’ Advances

Sometimes businessmen insist their customers make some advance payment. It is generally asked when the value of order is quite large or goods ordered are very costly. Customers’ advance represents a part of the payment towards sale price of the products, which will be delivered at a later date.

Customers generally agree to make advance payment when such goods are not easily available in the market or there is an urgent need of any goods. A firm can meet its short-term requirements with the help of customers’ advances.

5. Installment Credit

In business, credit that is granted on condition of its repayment at regular intervals, or installments, over a specified period of time. Installment credit is the means by which most durable goods such as automobiles and large home appliances are bought by individuals. The purchaser usually is advanced the goods after making an initial fractional payment called a down payment.

If the purchaser defaults on his payments at some point, all previous payments are forfeited to the seller, who may also taken possession of the goods.

6. Loans from Unorganised Sectors

The businessmen always have the option to take the money from the unorganised sector like loans from the moneylender (called indigenous bankers), friends and relatives. To meet the short-term and urgent need of business, money can be obtained from them either on personal security or on security of tangible assets and personal properties.

Since the interest charged on loans from unorganised sector is normally very high, the businessmen are not very keen to avail of loan from this source.

7. Inter Corporate Deposits (ICDs)

Deposits made by one company with another company for a short term are termed as Inter Corporate Deposits. It is a type of unsecured debt. It is arranged by a broker. This is a form of short term finance.

This source of finance is free from legal formalities. ICDs are kept secret and are not disclosed to the public. The interest payable depends on the amount and period of deposit. There is no organised market for exchanging these deposits.

Types of ICDs

Following are the different types of inter corporate deposits:

  1. Call Deposits: Call deposits can be withdrawn by the lender by giving a one day notice. The rate of interest on such deposits is 10% p.a.
  2. Three Months Deposits: These ICDs are for a period of three months. The rate of interest on these deposits is 12% p.a.
  3. Six Months Deposits: These ICDs are for a period of 6 months. The rate of interest on these deposits is 15% p.a.