Sources of Finance

NAME: Kanhaiya Kumar (1006) SEM IV

Overview
1. SHORT TERM FINANCING Short term financing refers to finance that must be repaid within one year. Types of short term credit include trade credit, bank overdraft, commercial bills, promissory notes, inter-company loans, factoring and leasing.

Trade Credit
Trade credit refers to the period that a vendor allows before payment is required. This type of finance is widely used because:
No interest charge is made by the lender;  It is relatively easy to obtain by businesses with a good credit rating; and  Being tied to the purchases of a business, the level of financing automatically grows as the business expands.


The normal terms of trade credit are net 30 days, or in other words, the invoice must be paid in full within thirty days. Sometimes a discount is offered to customers for early payment. One method of extending trade credit is known as stretching. This is the practice of postponing payments to creditors beyond the originally agreed period of time. This may be accepted by the supplier especially if the business is a regular customer.

Bank Overdrafts
A bank overdraft is an arrangement whereby the bank agrees to allow a business to overdraw its account up to a specified amount called the overdraft limit. The business has the freedom to overdraw the account up to the overdraft limit, and then replenish the account when funds become available.

Interest is calculated daily on outstanding balances and is charged to customers twice a year. In reality interest rates for overdrafts are usually arrived at through negotiations between the bank and the customer.

The overdraft limit and rate of interest, being subject to negotiations between the bank and customer, are usually dependant on three factors: 1. The bargaining position of the business. 2. The financial standing of the business. 3. The security given.

Commercial Bills
Commercial bills are bills of exchange that are drawn with the express purpose of providing finance to a business. Commercial bills have three parties: the drawer, the acceptor and the discounter.

The drawer is the party which draws up the bill requiring payment. The acceptor is the party which agrees to pay the drawer. The discounter is the party lending the funds to the acceptor. Figure 4.1 shows the commercial bill procedure.

Promissory Notes
The issue of promissory notes is a means of borrowing that is normally only available to companies with a very good reputation. This is because only one name (the borrowers) name appears on a promissory note and any holder relies on the standing of the promisor for payment.

The seller of a promissory note therefore incurs no contingent liability, in contrast with the case when a bill of exchange (commercial bill) is sold. To obtain funds, a company executes a promissory note and then has it underwritten by a merchant bank which arranges for tenders from a number of lenders. Alternatively, the company may approach the market itself.

The successful buyer of the note pays a face value minus a discount fee to the borrower On the due date the borrower pays the face value of the note to who ever is the holder at the time.

nter-Company Loans
The inter-company market is an informal market where amounts of $100,000 and upwards can be borrowed at call or for short fixed terms. Lending on this market is unsecured, thus the borrower must be financially sound and well known to the lender.

Due to seasonal nature of many businesses, a company with surplus funds to lend at one time of the year may be able to borrow funds at another time of the year form the same company it lent to earlier. The rates of interest paid on intercompany loans are usually below the bank overdraft rate, although they may rise above it during periods of tight liquidity.

Factoring
Factoring refers to either the assignment or the sale of accounts receivable to a finance company. In the case of an assignment, the finance company makes a loan with the accounts receivable as a security and then collects payment on those accounts as repayment of the loan. In the case that a customer defaults on a payment, the finance company has recourse to the borrower, who must make up the loss.

Factoring has three main drawbacks. 1. It is an expensive form of finance. 2. Because it is expensive, it is often regarded as being a last-resort method of financing and thus may affect the reputation of a company if it is known that it is using factoring. 3. The collection of accounts is taken out of the hands of the seller, who has no say in the collection policies of the factor.

Leasing
Leasing is a form of short term finance is regularly used to acquire the use of assets without having to purchase them. Leasing is widely used to obtain the short term use of a wide range of plant, machinery, equipment, vehicles and furniture. The lessee obtains the use of such assets by payment of lease rentals to the lessor.

This is an effective way of financing the use of an asset which is only needed for a short time.

RESEARCH ORIENTATION Shortlisiting the organization which use short term finance. Training approval Purpose of short tern finance requirement. Types of short term finance used presently and previuosly. If there is any shift in present types of STF from previous type, reason for that. Future plans about STF. If changed strategy is created for future purpose, reason for that. Lenders of STF.(Past, present and future prospect). Reason for switching over lenders of STF. Questionnaire fill up by finance manager and above ranked employees of the firm. Questionnaire fill up by competitors. Data evaluation and processing. Hypothesis testing through various statistical tools. Master sheet preparation and project submission.

STATEMENT OF INTENTION

By working on this project I am assured that I will not only work out the short term credit management of the organization where I am doing my on the job training but also I will be providing the data/information about the methods, lenders and sources of short term credit and its management by the firms competitors