Fundamentals of Business

Sources of short term finance

Trade credit exists when one firm provides goods or services to a customer with an agreement to bill them later, or receive a shipment or service from a supplier under an agreement to pay them later. It can be viewed as an essential element of capitalization in an operating business because it can reduce the required capital investment to operate the business if it is managed properly. Trade credit is the largest use of capital for a majority of business to business (B2B) sellers.

Credit given by one enterprise to another usually results when a supplier of goods or services allows the customer a period, default usually 30 days or (60,90, 120 days) before expecting an invoice to be settled.

Costs of trade credit
√ Invoices are usually submitted 'terms' net 'monthly' it may in practice be six weeks before settlement is made. This costs the creditor more than 1.55% (if annual interest is taken at 8%) in addition to the accounting and the collection costs.
√ Customers who take credit and thereby waive cash discounts forgo returns which for large purchases may amount to substantial sums per annum.

Bank credit (Overdrafts)
Commercial banks prefer not to advance long term loans which conflict their basic objectives of security and liquidity of funds. Although theoretically repayable on demand, overdrafts are generally renewable by negotiation and constitute a flexible and a relatively cheap source of working capital since interest is only payable on money borrowed.

√ Rates of interest the rates changed to a business person will be influenced by the following factors:
The current base rate to which overdraft and loan rates are linked (bank base rate plus 1.5 - 3%)
√ Credit worthiness of the borrower
Which will depend on:
The records of profits
the relation of assets to liabi liabilities lities lities.
The borrower's integrity and commercial goodwill goodwill.
The quality of available collateral and securities.

Bank bills finance
Bank bills of exchange are drawn on acceptance - credit facilities granted by merchant banks to their customers, preferably against short term self liquidating transactions, which realise funds to meet the bills at maturity. They offer the business person a relatively cheap and reliable source of short term credit.