Short Term Sources of Working Capital Financing

Here we discuss about Short Term Sources of Working Capital Financing.

S.T.F (Short-term finance) is raised by the company in covering day to day expenses and meeting short-term obligations. Short-term financing and Working Capital are related to each other. Short-term financing includes all those financial instruments and techniques adopted by the company to raise the cash needs to meet current obligations.

The company may get cash by investing in capital markets, investing in marketable securities and getting business loans from banks.

Sources of Short-term Financing 

Short-term Financing can be raised by the company through:

Ø Spontaneously Financing

Ø Negotiating Financing

Ø Spontaneously Financing

Spontaneously financing is utilized by default in conducting the daily business’s obligations and operating expenses.

Forms of Spontaneously Financing

Ø Account Payable

Ø Outstanding Expenses

Ø Account Payable

In account payable, the company is considering the trade liabilities and trade credit.

Ø Trade Liabilities

Almost all businesses take trade liabilities which are short-form of financing. In Trade liabilities, funds are utilized for short period of time, normally one year.

Ø Trade Credit

In trade credit, the company gets trade credit from another business without immediate payment. The well established businesses raise the funds through trade credit.

Advantages of Trade Credit

Ø Trade credit is the continuous form of credit. The company does not need to formally arrange financing.

Ø Trade credit is a more flexible source of financing because there are a not strict payment schedules.

Ø Outstanding Expenses

Outstanding expenses are also most important sources of short-term financing. Outstanding expenses mean expenses are incurred but not yet paid. Outstanding expenses are paid for a specified period of time. The most important outstanding expenses are wages.

Wages are paid daily, weekly, semi-monthly and monthly.

Ø Negotiating Financing

Negotiating financing is not spontaneous or automatic but the negotiating financing is arranged on formal basis.

Negotiating financing are external sources of short-term financing and these financing consist of the following forms:

Ø Money Market Credit

Ø Secured Loans

Ø Unsecured Loans

Ø Money Market Credit

Ø Money market credits are short-term financing and  It includes:

Ø Commercial Paper

Ø Bankers’ Acceptance

Ø Commercial Paper

Mostly larger organizations borrow short-term financing through this type of money market credit. Commercial paper (C.P) is used for short period of time, normally one year. Commercial paper (C.P) is transferable and unsecured promissory note traded in the money market. Due to money market instrument, only trustable companies are in a position to trade with this instrument.

There are two parts of commercial papers:

Ø Dealer Market

Ø Direct Placement Market

Ø Dealer Market

In dealer market, mostly industrial firms and medium-sized companies sell commercial paper through dealers. The dealer organization consists of 6 members who purchases commercial paper from the issuer and sells to the investors.

Ø Direct Placement Market

In this market, the larger organizations, that have excess cash, sell the commercial paper directly to the investors. The issuers tailor both the maturity and the amount of notes to the needs of the investors.

Ø Bankers’ Acceptance

When the company is involved in foreign trade or the local shipment of specific marketable securities, then the bankers’ acceptance is the best source of financing for the company. Bankers’ acceptance is a short-term promissory note in which bank promises to pay the face value to the holder of the promissory note at the maturity.

If the banks are credible and have good financial position then the acceptance given by the bank makes the instrument highly remarkable.

It is better for understanding those purposes that divide the business loans into unsecured and secured loans.

Ø Unsecured Loans

These are the loans which are taken by the company to purchase assets that generate enough cash flows for the business to pay off the debts. Unsecured loans are taken without any pledge on assets against the loans. These types of loans are well known in the field of finance, especially in the case of account receivable and inventories. Unsecured loans are expanded under the three bases:

Ø Line of Credit

Ø Revolving Credit Agreement

Ø Transaction Loans

Ø Line of Credit

In line of credit, there is an informal agreement between the bank and the clients to get specified maximum amount of loan at any one time. Normally, line of credit is issued for the period of one year and can be renewed by bank after receiving and reviewing the annual reports.

Ø Revolving Credit Agreement

Revolving credit agreement is a formal agreement between the bank and the clients to extend the amount of loan up to maximum limit over specified period of time. The bank is bound to extend the credit when the clients fulfill the condition that the total amount of loans does not exceed the specified maximum amount of loan. The borrower is required to pay commitment fees to lender in honor of the commitment.

Ø Transactions Loans

When financial institutions provide loan to contractors for the completion of the project, then the financial institutions treat every demand of the contractors for taking the amount of loan as a different transactions. Transaction loans are made only by the banks when the borrower has enough cash to make the payment of loan.

Ø Secured Loans

Secured loans are given by banks to those companies that are not well known and there is possibility that the companies may not be able to pay off the amount of loan. Secured loans are given against the security because there may be chance that the borrower may fail to pay off the loan and as a result banks suffer.

Now we finish our topic "Short Term Sources of Working Capital Financing.". Hopefully, it will helpful for you.