Short – Term Sources of

Finance
 MEANING
 Short-term financing means business financing from short-term sources, which are for less
than one year. The same helps the company generate cash for working of the business and for
operating expenses, which is usually for a smaller amount. It involves developing money by
online loans, lines of credit, and invoice financing.

It is also referred to as working capital financing and is used for inventory, receivables, etc. In
most cases, this type of financing is required in the business process because of their uneven
cash flow into the business or due to their seasonal business cycle
 TYPES OF SHORT- TERM LOAN
 BANK OVERDRAFT : Bank overdraft is a type of financial instrument that is provided to
some customers by the bank in the form of an extended credit facility, which comes into effect
once the main balance of the account reaches zero.

In other words, bank overdraft is an unsecured form of credit that is mainly used for covering
short term cash requirements.

Banks offer a credit limit to the bank customers based on their relationship with the bank. The
bank levies separate interest and charges towards non-maintenance of account. The interest rate
for the overdraft facility may vary from bank to bank.
Continued…
A Cash Credit (CC) is a short-term source of financing for a company. In other words, a cash
credit is a short-term loan extended to a company by a bank. It enables a company to withdraw
money from a bank account without keeping a credit balance. The account is limited to only
borrowing up to the borrowing limit. Also, interest is charged on the amount borrowed and not
the borrowing limit.

Example of Cash Credit

Company A is a phone manufacturer and operates a factory where the company invests money
to purchase raw materials to convert them into finished goods. However, the finished goods
inventory is not immediately sold. The company’s capital is stuck in the form of inventory. In
order for Company A to meet its expenses while waiting for its finished goods inventory to
convert into cash, the company takes a cash credit loan to run its business without a shortfall.
Continued…
Bills Discounting : term bill discounting refers to receiving the amount of the bill or the invoice
by exchanging the same at a preferred or partner lender of the beneficiary of the invoice but not
at the full amount of the invoice. The banks charge a percentage of fees for such benefit which
essentially means that the bill is discounted at a particular rate. The banks or lenders earn a
percentage of fees for such service provided to the beneficiary and the beneficiary receives the
dues of the bill immediately without having to wait till the end of the credit period.
The invoices discounted under this practice are known as bills of exchange. Bill discounting is a
form of loan that is available to the beneficiary of the invoices and has to be repaid if the bank or
the lender does not realize the amount of the bill when presented to the buyer at the time of
maturity or at the end of the credit period.
 Continued….
The ‘Ploughing Back of Profits’ is a management policy under which all profits are not distributed amongst
the shareholders, but a part of the profit is ‘Ploughed back’ or retained in the company.
These retained earnings are utilized in future for financing modernization and expansion programmed and
for meeting the fixed or working capital needs of the company. Since it means dependence on internal
sources for meeting the financial needs of the company. It is also called ‘Internal Financing’ or ‘Self Financing’.

The internal financing is regarded as an ideal method of financing expansion schemes because there is no
immediate pressure to pay any return on this portion of stock holders’ equity. It is an adjunct of sound
financial management.

It creates no legal formalities as do borrowing either from the public or from the banks. The policy of
ploughing back is a sound method of funding the projects of established concerns without disturbing their
capital structure.
ADVANTAGES OF SHORT TERM
LOANS
Maintains Cash flow
A consistent cash flow is required to clear the overhead expenses and operational costs in
business. In case of shortage of daily cash flow, small cash loans are a good option. It saves
businesses from sinking during the low season and eliminates risk of shutting down.

Balancing Seasonal Demands

Businesses that experience highs and lows based on the seasonal products undergo financial
difficulties as the products are sold only for a particular season. In case extra seasonal products
remain, it turns into dead stock. Hence, to cover up this loss for the rest of the year, small cash
loans can be borrowed to balance the expenses.
CONTINUED……
Handle Emergencies
Emergency situations on the business front are quite expected. In case of natural calamities,
technical breakdown, equipment repairs or connectivity issues, short-term loans can help to with
stand the emergency expenses.

Improve Credit Score

The credit score increases when EMIs are paid on time. Short term loans are less as compared to
long term loan amounts. Hence, can be repaid easily in EMIs without much difficulty. The scope
of delayed EMI payments is less in short-term loans.
DISADVANTAGES OF SHORT TERM
LOAN
Higher Interest
As the loan amount is less, the interest rate charged on the loan amount is higher. This makes the
repayment figure heavy. So, always look for the prevailing interest rate before applying for any loan.

Affects Credit Score

Missed or failed attempt to make loan repayment can bring down the credit score. This can create
problems in future loan approvals.

Early Repayment Penalty

You may want to clear the loan at once before the due date. But there are lenders who levy prepayment
penalties as the amount of interest charged is not earned as profit.