Sources of Short-Term Finance and their Merits

Sources of Short-Term Finance

Important sources of short-term finances are Trade Credit, Cash Credit, Advance by Customers, Accrual Account, Short-term Public deposits, Overdraft, Discounting of Bills and Short-term loans. They are briefly explained as follows.

1. Trade Credit

Trade Credit is the credit guaranteed by the seller of the goods to the buyer of the goods. The duration of the credit may be from 30 to 90 days. It is also known as mercantile credit. This credit arises during the course of business. It helps the buyer of goods to make payment for the purchase after few days. No interest is payable on trade credit. The seller provides credit based on the creditworthiness of the firm and volume of purchase made by him.

Merits of trade credit

1. It enables a business organization to make payment for the purchase of goods at a later date.

2. It does not require legal formalities.

3. It does not create any charge on the assets.

2. Cash Credit

It is an arrangement by which a banker allows the organization to borrow money upto a certain limit. The cash credit limit is fixed by the bank based on the credit worthiness of the business organization.  The cash credit is granted by the bank in the form of cash. Cash is given only against some security or guarantee.

Merits of cash credit

1. The business organization can withdraw money as and when the financial requirement arises.

2. The interest has to be paid by the business only on the amount withdrawn. Interest need not be paid on the total amount sanctioned

3. It helps to meet the flexible working capital needs

3. Advance by Customers

The buyer of the goods provides advance to the seller for the purchase made by him. Sometimes, the customer or the buyer pays the full price of the goods. The advance paid by the buyer depends on the reputation of the seller, conditions prevailing in the markets and customs of trade.

Merits of Advance by Customers

1. It does not carry any interest on the short term funds.

2. It helps the business to carry out production and business operations effectively.

3. It is a good source of flexible working capital.

4. It helps the buyer of goods to carry out the business operation without any interruptions.

4. Accrual Account

There always exists a time gap between receipt of income and payment of expenditure. For example, taxes, wages which are due are not paid immediately. For example, employee must have worked for a week. But wages are paid only after he puts his service for a week.

Merits of Accrual Account

1. Accrual account is a good source of finance as the payment of expenses is postponed for few days.

2. Accrual account does not carry any interest.

3. Accrual account can be opted as a last resort without disturbing the reputation of the firm.

5. Short Term public deposits

They are the deposits raised by the public for a shorter period. The interest paid on deposit is less as the money is invested by the public for a shorter period.

Merits of Short-Term Public Deposits

1. It is a good source of flexible working capital.

2. It is the cheapest source of raising short term funds.

6. Overdraft

It is the facility provided by the bank to its current account holders. The current account holders can withdraw upto a certain limit over and above the credit balance available in the current account.

Merits of Overdrafts

1. The current account holders can withdraw when the needs arise

2. It enables the business to withdraw more than the balance available in the current account.

3. It is a good source of flexible working capital

7. Discounting of Bills

A customer or a business organization that has a bill of exchange can discount the bill with a commercial bank. The bank gives advances to the customer by discounting their bills.

Merits of Discounting of Bills

1. It is a cheaper method of raising working capital.

2. It is an effective method of financing and utilization of credit.

3. It is a cheaper source of short term finance.

4. Bank has got different schemes for financing. Hence it is flexible in nature.

5. The bank provides finance at concessional rate of interest.

8. Short Term Loans

Lump sum amount provided by the banker to the borrower for a short period is called short-term loan. It charges a fixed rate of interest.

Merits of Short-term loans

1. It is a cheaper source of finance as the interest charged by the bank in case of short term loans is lesser than cash credits and overdrafts.

2. It helps to meet the working capital needs.