The definition of short-term finance is providing financial support to businesses from short-term sources. Offered for a time of lower than a year, it is good helpful support. It involves producing cash by lines of credit, online loans, and invoice financing.
This generated cash helps in the operating expenses and working of the business. Short-term finance is also known as working capital financing.
It is basically utilized for receivables and inventory. The reason why this financing is crucial is that businesses have uneven cash flow. The various types of short-term finance are given below.
Types of Short Term Finance
1) Trade Credit
This type is defined as the time which is given to businesses in order to pay for services and goods which they have bought. The allowed floating time is usually 28 days. The trade credit is effective because it helps in better management of the finances and the cash flow.
With trade credit, one can finance the inventories which decide the number of days a vendor is given prior to the due date of payment. The vendor offers trade credit in the form of an inducement for the growing business. This is the reason why it is free.
2) Working Capital Loans
Most financial institutions including the bank increase loans for a lesser time period after monitoring the past records, nature of the business, the working capital cycle, etc.
When a loan is sanctioned and given by the bank, it can be returned in easy installments or even be repaid once before the loan tenure period ends.
This loan tenure is established after the terms of a loan between the two parties are accepted. It is wise to financially support the working capital requirements permanently by using the loans.
3) Business Line of Credit
This type of short-term finance is an effective method to fulfill the working capital needs. A business has to visit banks in order to get the permission of a specific sum depending on the credit line structure. This structure is judged by the credit score, projected inflows, and model of business.
A maximum approved amount is also set. The business can withdraw within this maximum amount whenever requires. Moreover, when the amount is available to the business, it can be deposited or repaid.
As for the interest, it is charged on the used sum according to the daily reducing balance way. In this way, the business line of credit is a very resourceful and cheap method of financing.
4) Invoice Discounting
This is defined as the arrangement of funds as opposed to the submission of invoices. This submission depends on the payments which will be gained in the future. The discount with third parties, banks, and any financial institution are made for the receivables invoices.
When the bills are paid, these institutions pay for the discounted value of bills. When the due date arrives, these institutions also collect the payment in the place of the business.
This type is similar to the invoice discounting with respect to the arrangement. Basically, it is debtor finance by which the business sells the accounts receivable to a third party. This third party can be known as the factor. It is very cheap.
The factor can be of any category irrespective of the availability of the recourse. As for the invoice discounting, it can only be done with the recourse.
Advantages of the Short Term Loans
- Fast disbursement: The short-term loan has a comparatively lesser probability of risk as compared to a long-term loan. This is because the long-term loans have an extended maturity date. Therefore, the defaulting of the loan payment for the short term is easier. Very little time is needed for the sanctioning because of the short maturity date. This is why the short-term loan is sanctioned and disbursed at a very fast rate.
- Less interest: Due to the fact that short-term loans have to be repaid in lesser time, usually less than a year, the sum of the interest cost becomes very less. As opposed to long-term loans, they are easy. The interest rate on a long-term loan can sometimes be higher than the loan itself.
- Little documentation: Since the short-term loan is very less risky, not many documents will be required.
Remember that the main reason for choosing short-term finance is to have funds for the working capital. Moreover, the cycle should be run effectively and the fund does not create a problem in the routine of business.