Short-Term Sources of Funds
Short-term sources of funds refer to financing methods that provide businesses or individuals with capital that typically must be repaid or reconsidered within a year or one operating cycle. These sources are essential for maintaining liquidity and managing the working capital needs of an organization.
Here are some common short-term sources of funds:
- Trade Credit: Suppliers often provide goods on credit, which means businesses can purchase now and pay later. This delay in payment (e.g., 30, 60, or 90 days) effectively acts as a short-term source of funds, as it allows businesses to utilize the goods and potentially earn revenue before needing to pay for them.
- Short-Term Bank Loans: Banks and other financial institutions offer short-term loans that typically need to be repaid within a year. These can come in the form of working capital loans, bridge loans, or demand loans.
- Bank Overdrafts: With a bank overdraft, businesses are allowed to withdraw more money from their bank account than they have. It’s like a short-term loan and is subject to interest charges.
- Commercial Paper: Larger companies with good credit ratings might issue commercial paper. This is an unsecured, short-term debt instrument issued to raise funds for immediate needs. It usually matures in a range from a few days up to 270 days.
- Factoring: This involves selling accounts receivables (invoices) to a third party (a factor) at a discount. The factor advances most of the invoice amount to the business, holds back a portion until the invoice is paid, and then takes a fee from the withheld amount.
- Accruals: These are liabilities or expenses that are recognized before they are paid. Examples include wages payable or taxes payable. By accruing these, a business essentially postpones the actual cash outlay.
- Short-Term Notes Payable: As discussed in previous answers, these are formal debt instruments where the business promises to pay back a lender a specific amount within a short period, typically less than a year.
- Advances from Customers: Some businesses might receive payments in advance from customers, especially for large orders, customized work, or subscription-based services. These advances provide immediate liquidity.
- Inter-Corporate Loans: These are short-term loans granted from one company to another, usually within the same group of companies.
- Sale and Repurchase Agreements: Commonly referred to as “repos,” these are agreements where an entity sells an asset (typically financial assets like securities) and agrees to repurchase it at a later date, usually at a higher price.
When deciding which short-term source of funds to pursue, businesses should consider factors like the cost of financing (interest or fees), repayment terms, the flexibility of the source, and any potential impacts on creditworthiness or business operations.
Example of Short-Term Sources of Funds
Let’s walk through a fictional scenario involving a business and its use of various short-term sources of funds.
Scenario: GreenLeaf Nurseries
GreenLeaf Nurseries, a small business specializing in a variety of plants and gardening products, anticipates a surge in sales in the upcoming spring season. To prepare for this, the nursery needs to stock up on inventory, hire temporary workers, and launch a marketing campaign. However, GreenLeaf is short on immediate funds to cover these expenditures.
Here’s how GreenLeaf taps into various short-term sources of funds:
- Trade Credit: GreenLeaf negotiates with its suppliers to get plants and gardening tools on a 60-day credit term. This allows the nursery to stock up without immediate payment, effectively using $20,000 of trade credit.
- Short-Term Bank Loan: To fund the marketing campaign and hire temporary workers, GreenLeaf takes out a $10,000 short-term loan from its local bank with a maturity of 6 months.
- Bank Overdraft: Given the unpredictable nature of sales, GreenLeaf secures an overdraft facility of $5,000. This provides a safety cushion, ensuring that they can cover unexpected expenses without bouncing checks.
- Factoring: GreenLeaf has $8,000 in accounts receivables from some corporate contracts. They factor these receivables, getting an immediate $7,200 (90% of the value) from a factoring company.
- Advances from Customers: A local community club places a large order for an upcoming event and pays $3,000 in advance.
Using these short-term sources, GreenLeaf Nurseries gathers:
- Trade Credit: $20,000
- Short-Term Bank Loan: $10,000
- Overdraft Facility: $5,000 (to be used as needed)
- Factored Receivables: $7,200
- Customer Advances: $3,000
Total Available Short-Term Funds: $45,200 (excluding unused overdraft)
With these funds, GreenLeaf can confidently stock up, hire staff, and initiate their marketing campaign, all while effectively managing their cash flow.
This example showcases how a business can strategically utilize multiple short-term financing methods to navigate a period of increased operational demand.