Short Term Financing – Interest Free Sources and Unsecured Interest Bearing Sources
A firm obtains its funds from a variety of sources. Some capital is provided by suppliers, creditors, and owners, while other funds arise from earnings retained in business. In this segment, let me explain to you the sources of short-term funds supplied by creditors.
Characteristics of short-term financing:
Goals of Short-Term Financing:
Interest Free Sources:
Accounts payable are created when the firm purchases raw material, supplies, or goods for resale on credit terms without signing a formal note for the liability. These purchases on “open account” are, for most firms, the single largest source of short-term financing. Payables represent an unsecured form of financing since no specific assets are pledged as collateral for the liability. Even though no formal note is signed, an accounts payable is a legally binding obligation of a firm.
Postponing payment beyond the end of the net (credit) period is known as “stretching accounts payable” or “leaning on the trade.” Possible costs of “stretching accounts payable” are
These are short term liabilities that arise when services are received but payment has not yet been made. The two primary accruals are wages payable and taxes payable. Employees work for a week, 2 weeks or a month before receiving a paycheck. The salaries or wages, plus the taxes paid by the firm on those wages, offer a form of unsecured short-term financing for the firm.
The Government provides strict rules and procedures for the payment of withholding and social security taxes, so that the accrual of taxes cannot be readily manipulated. It is however, possible to change the frequency of paydays to increase or decrease the amount of financing through wages accrual.
Wages — Benefits accrue via no direct cash costs, but costs can develop by reduced employee morale and efficiency.
Taxes — Benefits accrue until the due date, but costs of penalties and interest beyond the due date reduce the benefits.
Unsecured Interest Bearing Sources:
The bank provides funds for a seasonal or cyclic business peak and the money is used to finance an activity that will generate cash to pay off the loan.
Borrowed Funds → Finance Inventory → Peak Sales Season → Receivables → Cash → Pay Off the Loan.
Three types of unsecured short-term bank loans: