Business Growth

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Sources of Short-Term Capital By Mrs. Belen
Apostol
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Sources of Short-term Capital

• The total business finance function is composed
  of three segments
• Short-term financing
• Intermediate-term financing
• Long-term financing
• Short-term financing deals with the demand for
  supply of short-term funds which may either be
  secured or unsecured.

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Advantages of Short-term Credits

• They are easier to obtain the risk involved in
  lending funds varies according to the length of
  payment period.
• e.g. long-term credits are more risky than
  short-term credits from the creditors point of
  view.
• 2. Short-term financing is less costly
  short-term credit is often granted by creditors
  at less cost
• 3. Short-term financing offers flexibility to the
  borrower the debtor may use other sources of
  credit after the short-term credit is settled.

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Disadvantages of Short-term Credits

1. Short-term credits mature more frequently firms
   with slow moving inventories like manufacturing
   capital goods worry about short-term creditors
   more often.
2. Short-term debt may at times, be more costly than
   long-term debts-risk, collateral, general
   economic outlook and size of the loan are taken
   into consideration. Short-term credit may prove
   to be more costly.

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The Suppliers of Short-term Funds

1. Trade creditors
2. Commercial banks
3. Commercial paper houses
4. Finance companies
5. Factors
6. Insurance companies
7. Company accruals

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Trade Creditors

• Trade creditors credit extended by suppliers to
  buyers for use in manufacturing, processing, or
  reselling goods for profit. (from firm to another
  firm)
• - usually unsecured
• - also known as trade credit, commercial
  credit, mercantile credit or accounts receivable
  credit.
• - appears as accounts receivable/ notes
  receivable in the books of the creditors, and as
  accounts payable or notes payable in the books of
  the debtor.

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Trade Creditors

• Consumer credit credit extended to a final
  consumer.
• Installment credit credit extended to a firm in
  the purchase of machinery and equipment and
  secured by the equipment sold.

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Trade Credit Instruments

• Open-book credit constitutes a bulk of trade
  credit, unsecured and permits payment for goods
  delivered in a specified number of days.
• - source of inventory financing
• 2. Trade Acceptance a time draft drawn by a
  seller to a purchaser, payable to the seller as
  payee, and accepted by the purchaser as evidence
  that goods shipped are satisfactory and that the
  price is due and payable.

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Trade Credit Instruments

• 3. Promissory Note unconditional promise in
  writing made by one person (maker) to another
  (bearer), engaging to pay on demand or at a fixed
  or determinable future time, a sum certain in
  money.
• - made by a buyer who has a weak credit
  position.
• Advantages
• the time and amount of payment are indicated,
  avoiding litigation over such matters
• may be endorsed to other parties allowing the
  creditor immediate use of funds tied up in such
  credit arrangement.

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Trade Credit

• Cost of Trade Credit.
• Firms extending trade credit provide incentives
  to firms who settle their accounts early. Those
  who do not avail of the trade discount incurs
  cost related to the trade credit which may be
  computed as follows
• Annual cost of Discount 360 days
• Not taking ------------- x
  ----------------------
• Discount 1 Discount Number of - Discount
• days credit period

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Trade Credit

• Cost of Trade Credit.
• If the credit term is 2/10, net 30 , the annual
  cost is computed as follows
• Annual cost of .02 360
• Not taking ------------- x
  ----------------------------
• Discount 1 0.02 30 days 10 days
• .02 360
• ------------- x ------------------------
  ----
• .98
  20
• 36.73

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Commercial Banks

• Commercial Banks institutions which individuals
  or firms may tap as a source of short-term
  financing.
• - corporations which accept or create deposits
  subject to withdrawal by check.
• Four Components
• Commercial Banks
• Development Banks
• Savings Banks
• Rural Banks

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Commercial Banks

• Short-term loans those with maturity periods of
  one year or less
• -generally offered by commercial banks for
  purposes which included financing of business
  activities.
• Two types of Short-term loans
• Unsecured loan (clean loan) - does not require a
  collateral
• Secured Loans requires a collateral back-up
  usually for accounts receivable financing or
  inventory financing. (a collateral is usually
  required when the credit standing of the borrower
  is inadequate to permit unsecured loan).

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Commercial Paper Houses

• Commercial Paper short-term promissory note,
  generally unsecured which is sold through
  commercial paper dealers or directly to
  investors.
• - used to finance companies and business firms
  that borrow funds in the money market.
• Commercial Paper Houses (CPH) firms that buy
  commercial papers.
• - finance short-term fund requirements of
  borrowing firms.
• - include banks and other financial
  institutions, like those engaged in selling
  insurance, educational, pension and mortuary
  plans.

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Finance Companies

• Finance Companies engaged in making short and
  intermediate term installment loans to consumers,
  factor or finance business receivables, and
  finance the sale of business and farm equipment.
• - funds are raised by issuing stock, bonds,
  borrowing from banks, and selling their
  commercial papers.
• Three major types of finance companies
• 1. Sales finance companies
• 2. Business or Commercial finance companies
• 3. Personal finance companies

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Finance Companies

• Sales Finance Companies firms specializing in
  the purchase of retailers of the installment
  receivables arising out of retail sales of
  automobiles, household appliances, industrial
  equipment, farm equipment, and other durable
  goods sold on the installment payment plan.
• Business or Commercial Finance Companies lend
  directly to a wide variety of businesses, mainly
  of small and medium size. Short-term loans are
  granted by this type of finance companies against
  the security of assigned accounts receivable,
  inventory, and equipment.

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Finance Companies

• Business or Commercial Finance Companies (cont)
• When using accounts receivable as collateral,
  the loan arrangement may be considered as
• Non-notification plan the debtors of the
  borrowing firm are not aware that their accounts
  have been pledged as collateral for a loan from a
  finance company.
• Notification plan debtors are informed that
  their accounts have been pledged as collateral
  for a loan from a finance company.
• Personal Finance Companies engaged principally
  in personal loans. (may include miscellaneous
  business loans commercial accounts
  receivable loans.)

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Factors

• Factoring purchase of accounts receivables
  outright without recourse to the seller for
  credit losses.
• - the factor takes it upon himself to collect
  the funds from the clients customers, absorbing
  any credit losses incurred.
• A claim for defective goods or dispute
  concerning shipments, is not the responsibility
  of the factor.
• Advantages
• Receivables provide collateral for a loan that
  might not be otherwise available to the firm
• Accounts receivable financing provides
  flexibility to the firm.

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Insurance Companies

• Insurance companies provide a stable source of
  short-term funds.
• - invest on short-term commercial papers and
  promissory notes

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Company Accruals

• Accrual expense that has been incurred but has
  not yet been paid.
• - provide a source of short-term financing for
  business firms.
• Two forms
• Accrued Wages and Salaries salaries are paid as
  soon as they are rendered.
• Accrued taxes taxes has a longer time lag
  before it becomes due.

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Financing Requirements of the Firm the Sources
of Short-Term Capital
Financing Requirements of the Firm
Short-term
Medium-term
Long-term
Open book
Trade creditors
Trade acceptance
Promissory note
Secured loan
Commercial bank
Unsecured loan
Commercial paper houses
Finance companies
Sales finance companies
Business finance companies
factor
Personal finance companies
Insurance companies
Company accruals
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