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Short Term Financing

Short Term Financing
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: Cost of Funds: Some forms of short-term financing may prove to be expensive than that of intermediate and long-term financing while some short-term sources like Accruals and Payables provide funds at no cost to the firm. Rollover Effect: Short-term finance as the name indicates must be repaid within a period of one year – though some sources provide funds that are constantly rolled over. The funds provided by payables, may remain relatively constant because, as some accounts are paid, other accounts are created. Clean-up: This happens when commercial banks or other lenders demand the firm to pay-off its short term obligation at one point in a financial year. Goals of Short-Term Financing: Funds are needed to finance inventories during a production period. Short term funds facilitate flexibility wherein, it meets the fluctuating needs for funds over a given cycle, commonly 1 year. To achieve low-cost financing due to interest free loans. Cash flow from operations may not be sufficient to keep up with growth-related financing needs Interest Free Sources: Accounts Payable 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      Cost of the cash discount (if any) forgone      Late payment penalties or interest      Deterioration in credit rating  Accruals: 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: Self-Liquidating Bank Loans 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: Single payment note – A short-term, one-time loan made to a borrower who needs funds for a specific purpose for a short period of time. Line of Credit – An informal arrangement between...
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Debtor Management or Receivables Management

Debtor Management or Receivables Management
Debtor Management or Receivables Management Profit is directly proportional to the volume of sales, provided all your business transactions are cash based. Is it possible for a manufacturer, wholesaler or retailer to carry on his business without offering credit in this competitive business environment? The answer is a definite “no”, because extension of credit improves your sales and thus your profit. Problems arise only when a firm is not able to recover the debt within the stipulated period of time from the customers. What is receivables management or debtors’ management? It covers two aspects- one, the kind of money that is being invested in debt rotation; second, the risk factor which includes loss of money or the opportunity cost foregone by the organisation. Had these funds not been tied in receivables, the firm would have invested the same elsewhere and earned income thereon. A transaction entirely through cash is definitely a possible option, but whether it is lucrative in the long run must be subject to consideration. When customers are not offered credit, they choose concerns that extend credit facilities and thus you may lose your earlier customers and also exposed to the risk of declining sales proportions. Credit Sales In credit sales, the supplier offers credit for a specific time period, which is an investment from the angle of supplier and largest single source of short term financing from the angle of the customer. The supplier should be able to recover the amount of interest on the credit investment he has made. How? Recovery of debt within the stipulated credit period Taking interest from the customer for the period of delay Volume sales Surplus capital to offset these negative impacts on rotation of funds Proper formulation and execution of credit policies by the finance manager Discipline in collection policy and its execution. Discounts Cash discounts, quantity discounts and trade discounts are offered by many firms to the customers to encourage credit sales, favoring bulk purchases. A firm cannot be expected to survive long by pursuing the policy of cash sales while similar firms can overtake it by adapting to liberal credit policies. The main aspects of receivables management decisions are as follows: Time period of credit Credibility of the customer Cash discounts Trade discounts Learn the basics of the Income Statement, Balance Sheet and Cash Flow Statement and understand how they fit together. Credit Policy Credit policy on one hand stimulates sales and so also its gross earnings, but on the other may be accompanied by added costs, such as: 1) Clerical expenses involved in investigating additional accounts and servicing added volume of receivables, 2) increased bad-debt losses due to credit extension to less credit worthy customers, 3) higher cost of capital. Incremental earnings from increased sales should be matched with incremental costs that arise due to credit terms, to avoid funds being tied up in receivables. In course of time it would deprive you of your profits. The pivotal consideration of your credit policy would be the selection of credit worthy customers or debtors. If your funds become sticky, recovery becomes next to impossible and you need to proceed legally to claim your rights. Properly maintained accounting records and vouchers will stand as a testimony in your favor, in the court of...
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