Sources Of Short-term finance

Description

Bank Overdrafts

• Simplest and most flexible type of short term finance for most business;

• Given a maximum limit;

• Interest is charged only on those utilized;

• Unutilized amount might be charged a small % of commitment fee;

• This facility is given on top of what the owner has in his/her current account;

• Generally about 2%-5% above the lender bank’s base lending rate. Premium spread like 0.25% to 0.75% are given by the lender bank to their high valued customers;

• Flexible because the borrower can reduce his overdraft as and when he wants by merely banking into his current account which has the overdrawn amount;

• The main disadvantages are this type of facility is repayable on demand and normally the borrower need to provide security/collateral for the overdraft facility.

Short-term loans

• Fixed amount and have a fixed period of time to repay the loan;

• Interest rate is fixed;

• Duration from few months to few years;

• Repayments either in installments or bullet type meaning one lump sum repayment;

• Interest is charge on the amount borrowed;

• Like bank overdraft, need to provide security or collateral for the lender bank;

• Advantage – the company does not need to pay back immediately especially when they embark on medium to long term projects/investments. So it is more secure than bank overdraft;

• Disadvantage – the interest rate is fixed. Un-conducive particularly when interest rates trends are moving downward;

Revolving Credit

• Borrowing for a short period of time say ninety days but renewable when expiry date is due;

• Has the feature of both short-term and medium-term loans as the borrower can keep repaying and borrowing for a few years

Bridging loans

• Normally applies to property based or project financing

• Loans are given for a specified period of time and coincides with the date the funds to repay. For example, in a housing project, a bridging loan of $XXmillion is repayable when the house owners commence to pay the housing developer.

Debt Factoring

• The lender bank or finance company takes over the company’s trade debts in return for a commission;

• Services offered include debt collection and administration, credit insurance and finance provision;

• Debt collection and administration includes taking over all the trade debts and manages the collection of debts for a fee/commission;

• Credit insurance is the paying in advance certain portion of the face value of the debts say 85%. Two types: recourse and non-recourse factoring arrangement. Recourse means that in the event of bad debts, the company will absorb it whilst non-recourse is that the factoring company will absorb the bad debts but will charge a higher commission for doing so;

• Finance provision is similar to recourse factoring.

Invoice discounting

• Similar to factoring. The lender will advance a percentage of the trade debt;

• The collection and management of the trade debt is done by the company and not the lending institution;
• The borrower to repay amount advanced plus interest charged.

Trade credits

• Credit extended by the supplier of goods and/ services;

• Normally for a period of 30 to 90 days;

• Credit term given by suppliers will depend on the company’s financial position and whether discount is taken or not;

• Interest free unless if supplier offers discount and borrower did not pay to enjoy the discount benefit;

• Therefore, the “cheapest” source of finance but should be handled properly otherwise company’s reputation might be ruined if it overstretch the credit term given by the suppliers.