In a very simple language short term finance meaning is a loan that you need to pay for less than a year or one. People basically prefer taking short term loans because it can be taken easily and repaid within a year so no burden is carried forward for more than a year. As the short term financing is available to take less amount it can be easily granted and taken also the repayment process is very easy.
Overall, Short-term finance involves obtaining a loan for a purchase with a duration of less than a year. There are other different forms of short-term funding, but the most well-known ones include "Buy Now, Pay Later," "Unsecured Personal Loans," and "Payday Loans." Read the blog ahead to understand short-term financing and help your businesses make informed decisions.
Did you know? The most commonly used short term finance is trade credit. This credit is allowed by the supplier to the buyer which also allows the receiver to pay later for the product which they are buying at the current period of time.
Definition of Short Term Financing
Short-term financing can be defined as funding received from small-term sources. It is not permanent, but for a very small period, say one year or less. Short-term financing helps the company create plans for spending the expenses for the smooth working of the business, which is mostly a very small amount.
This involves money through small online lending, credit lines etc. It is also known as working capital financing and is mainly used for checklists and receivables, etc. In case of irregular cash flow, many companies use short-term financing for their business regulation. It is one of the chief functions of finance that controls the need and supply of money for a lesser period. The most commonly used pattern of short-term financing is a bank loan.
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How short-term finance can help businesses?
Most companies prefer this method as it is for a short time, it is less risky, and cost-efficient and companies find it flexible to repay it. Hence, short time financing is very helpful for the business. Let us know how through the points ahead.
To maintain their urgent expenses
Many companies when they face any kind of emergency like urgently buying machinery and other stuff take up the help of small-scale loans which immediately helps them to cover up the losses and becomes a helping hand.
Regulate cash flow
Maintaining cash flow is a positive aspect of financing as it adds to the asset of any company. Regulation of cash flow is important as the amount of cash received becomes a positive sign for the company.
Types of cash flow
Cash flow is the net amount of cash and cash equivalent that is transferred in and out of the company. The inflow of the cash denoted the money which flowed inside the company. The cash which goes outside the company is known as outflows. Let us know the different types of cash flow.
Positive cash flow
When the amount of cash the company is receiving is greater than the payments made by the company, it is known as positive cash flow.
Negative cash flow
When the cash outflow from the company is greater than the amount the company is receiving.
Increase business opportunities
While short-term financing, in general terms, is help from financial institutions, it can increase business opportunities for a corporation working on a level.
It can be used for increasing the business and adding more assets to it. for example: adding more machinery and manpower to an organisation adds to its assets.
Periodic recruiting costs
Some companies have seasonal staffing done every year but how they work and how much they add to their turnover is the final cost of keeping them. This cost may fluctuate.
Repair and maintenance of assets
To maintain the workforce, machinery, and other relations of an organisation, any company needs short-term finances for maintenance.
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Types of short-term financing
There are many different types of short term financing that are available under certain criterias, but overall all are beneficial to us in one or another way.
Trade credit can simply be defined as the time given without immediate payment of cash. It is used by organisations as a source of short-term financing.
It gives the companies a floating time to repay the amount. The general floating time of companies is 28 days.
For example - if any organisation buys a product at ₹500 per day at 100, the quantity will be 500*100 = 50,000.
It is a risk for the company to know if the buyer will pay back or not, so to avoid such losses, proper bills and notes are provided by the supplier as proof.
Business organizations are dependent on commercial banks for many purposes. Financial institutions first classify the kind of business, its assets and records and then finalize the loan procedure. It can be repaid according to the terms and conditions of the bank.
Small Bank Loan
A small bank loan is a type of loan that is bought to assist a temporary personal or business capital need. Short-term loans furnish rapid cash when your money float is lacking, have shorter compensation durations than usual loans and are an extremely appealing choice for small companies that are no longer yet eligible to practise for a line of savings from a bank.
It refers to arranging the money against submitting invoices whose repayments will be received shortly. The receivables invoices are discounted with the banks, economic institutions, or any third party. On submission of bills, they will pay the discounted cost of bills, and on the due date, they will gather the price on the business's behalf.
It is the limit of amount based on the credit score, records, projects and other inflows. The bank passes a limited amount as a loan and which can be used for business use. The best thing about the credit line is that the interest is charged on the amount utilised from the account and not on all the amount sanctioned. This reduces the burden on the company.
For flexible financing, factoring allows us to promote debts receivable and quickly obtain liquidity. Also, we can request protection in opposition to charge defaults.
Types of factoring
- Recourse factoring - any loss of bad debts will be borne via the business firm, or so they thought.
- Non-recourse factoring - A factor which executes an invoice purchase agreement with a company without asking the company to repurchase unpaid or past due accounts receivable is automatically non-recourse.
- Domestic factoring - if factoring is for domestic sales.
- Export factoring - if a financial institution is situated in an exporter's country.
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Example of short-term financing
Maya took a loan of ₹10,000 for six months at 5% interest. the loan is for a very short period, so it can be considered as short-term financing. Maya has to repay the loan and the interest.
Why is short-term financing important?
Short-term financing can help assist small startups and maintain the regular flow of money and other funds and other facilities by financial institutions. These can be blended with government financing for micro-businesses and other loans.
Advantages and Disadvantages of Short Term Financing
Short-term financing is known to be less costly and more flexible which makes it more favourable in nature. It can also be attained in a short period of time and repaid in less time which is not even a year. Also short term financing can be blended with government facilities by governmental institutions.
Advantages of Short-Term Financing
- Easy to get: companies find it easier and less risky to get a short-term loan.
- Less Risk: as compared to other methods of financing, this is less risky and can be repaid in a short interval of time.
- Flexibility: short-term financing is very much flexible as the amount is low, so the company can easily repay it. Also, there is a fixed floating time to repay the loan.
- A short period: short term as the name suggests, is for a very short period, namely 6 months or a maximum of 1 year.
Disadvantages of Short-Term Financing
- Less period- Firms working on large projects find it difficult and challenging to clear up previous small finances which becomes a hurdle for them in the long run.
- Expensive- When all the costs and budgets are viewed in comparison to small finance, sometimes it proves to be costlier than long-term finance.
Short-term finances are a way of gathering the financial requirements of the corporations for a short period. Thus, they are used to make everyday purchases and pay tax liabilities arising out. All businesses and projects need an amount to run smoothly. The small-term finance is just a basic push to keep things in working condition and get support from financial organisations on a small-term basis. Hope you have a clear understanding about short term financing and if you are planning to get some for your business then it cannot be a bad idea.
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