Sources of Short-term Financing
There are two kinds of financing which the firms often resort to for generating fresh financing for short term. For one, they could choose between several methods of getting the short term finances through banks. Such methods are usually resorted to by listed companies and other companies which have reasonable credit worthiness with their bankers. The other option is non-bank sources of securing short term financing. This option is primarily for the smaller or micro sized firms with little credibility. These options may be slightly more expensive than those offered by banks, In any case, bank sources prove out to be cheaper though they may require a longer wait for firms and are received only after passing through a due diligence of banks.
Methods popularly used by financially sound large companies include:
- Uncommitted line of credits: These are lines of credit usually extended by the banks, but the banks reserve the right to refuse the same in some cases, if the specific circumstances change, and affect the liquidity of the borrowers.
- Committed line of credits: These are small lines of credit, for which the bankers agree to offer some funds to companies or large organizations, for some specified period of time decided in advance. Since in such cases, bankers are committed to offer some credit upto a limit for a specified period to companies concerned, these are more reliable source of short term financing for the large companies or companies having a reasonable credit rating. These are usually extended by banks for a small period of less than a year of time, at an interest rate which varies almost in line with the reference rate of interest, or LIBOR rate, at a rate slightly higher than the reference rate. The rate charged over and above the reference rate, or LIBOR rate, is called the margin in US. In other countries, these are typically called as overdrafts line of credit.
- Revolving line of credit: These are typically for a longer period than just a year, and considered as a more reliable credit for the companies interested in getting credit for more than a year, at an interest rate, which also vary based on bank prime rate. Revolving credit lines can be verified and listed in the notes to accounts as credit lines in company’s financial accounts as a source of financing.
Apart from financially sound and more credible companies, the companies which are smaller and are not as much credit worthy, look for some sources of securing credit from the banks after offering a collateral to the banks for the credit they use or the blanket line of credit approved by banks. These collaterals could include receivables of the companies or the inventories of the companies as the most common items of the balance sheet. Such products for credit line for short term financing include:
- Banker’s acceptance: These are used by smaller companies which are into the export of goods or services. It is offered by banks to small companies which may have ordered goods, which suggests it would make payment for the goods ordered on receipt of such goods ordered. Such companies can sell such acceptance at a discount to generate immediate cash into the business.
- Factoring: It is the actual sale receivables at a discount from the face value, where the discount depends on the time in advance to which the actual time of receivable of such a payment by the exporting company. The credit worthiness of the customers is one of the key factors, apart from how much time in advance the company is getting the same discounted in advance to get an immediate payment, i.e., the time gap between actual payment may become due and when the company wants a payment factored in through a bank in advance. The buyer, or banker, takes the onus of collecting the payment by paying for same in advance at a discount for a margin.
For smaller firms and those having little credibility, the choice of selecting between sources of financing for short term financing is very limited. The cost of financing is also higher, if they secure such lending from banks, than that secured by bigger companies with a better credit rating. Small firms usually rely on non-banking sources of financing for short term, which are non-conventional methods. One of the popular methods is to look for commercial papers as an option by placing them either directly to investors or through dealers. In such a case, the interest rate for small company could be lower than any credit secured from banks.
All firms, whether smaller ones or the big companies, should ideally look for objectives of getting short term financing, before exercising any of the available options. The larger companies typically depend on having a good leverage by getting a high limit, even if they exhaust the credit limit sparingly only when required.