Sources of short term finance

Trade credit exists when one firm provides goods or services to a customer with an agreement to bill them later, or receive a shipment or service from a supplier under an agreement to pay them later. It can be viewed as an essential element of capitalization in an operating business because it can reduce the required capital investment to operate the business if it is managed properly. Trade credit is the largest use of capital for a majority of business to business (B2B) sellers.

Credit given by one enterprise to another usually results when a supplier of goods or services allows the customer a period, default usually 30 days or (60,90, 120 days) before expecting an invoice to be settled.

Costs of trade credit Invoices are usually submitted 'terms' net 'monthly' it may in practice be six weeks before settlement is made. This costs the creditor more than 1.55% (if annual interest is taken at 8%) in addition to the accounting and the collection costs. Customers who take credit and thereby waive cash discounts forgo returns which for large purchases may amount to substantial sums per annum.

Bank credit (Overdrafts) Commercial banks prefer not to advance long term loans which conflict their basic objectives of security and liquidity of funds. Although theoretically repayable on demand, overdrafts are generally renewable by negotiation and constitute a flexible and a relatively cheap source of working capital since interest is only payable on money borrowed. Rates of interest the rates changed to a business person will be influenced by the following factors: The current base rate to which overdraft and loan rates are linked (bank base rate plus 1.5 - 3%) Credit worthiness of the borrower Which will depend on: The records of profits the relation of assets to liabi liabilities lities lities. The borrower's integrity and commercial goodwill goodwill. The quality of available collateral and securities.

Bank bills finance Bank bills of exchange are drawn on acceptance - credit facilities granted by merchant banks to their customers, preferably against short term self liquidating transactions, which realise funds to meet the bills at maturity. They offer the business person a relatively cheap and reliable source of short term credit.

Costs of bank bills

Depend on the following factors: Current and expected short term market rates of interest. The period of credit. The rate of commission changed by acceptance houses which are determined by: a) the credit worthiness of the borrower. b) Nature and quality of security.

Factoring and invoice discounting Factoring and invoice discounting can boost cash flow by raising finance against outstanding invoices invoices. You will typically be able to borrow 80-85 per cent of the value of the invoice.

Companies of all sizes, including start ups, can use the service. However, it is generally considered most appropriate and cost effective for companies anticipating a high growth in turnover.

Factoring companies - known as factors - chase debts for you and pay you a fixed proportion of invoices within a pre arranged time and the balance of the invoice - minus their charges - once a customer pays up. With invoice discounting you are responsible for chasing the debt but can raise an advance on an invoice. As there is less work involved for the invoice discount company, charges are usually lower.

Advantages You can maximise your cash flow - rising up to 85 per cent on outstanding invoices. Factoring reduces the time and money spent on credit control. The factor's cred credit control it system will help assess the creditworthiness of new and existing clients. Factoring often protects you against bad debts debts. Factoring can reduce the cost and risk of doing business overseas overseas. If you don't want to pay for a collection service you can use invoice discounting.

Disadvantages The factor usually takes over your sales ledger - some customers may prefer to deal with you personally. Factoring may impose constraints on the way you do business. Factors may want to pre approve your customers, which could cause delays. When you want to terminate the agreement you will have to pay back the money that has been advanced to you against the invoices - requiring you to look at alternative forms of finance.

 Some invoice and factoring companies tie you into long termination notice periods - usually three months. Some companies require one year's notice, which could be costly for you.

Keeping the records - Financial documents

There are three important documents I. Cash (funds) flow Benefits from using Cash flow the cash flow statement is one of the four main financial statements of a company. The cash flow statement can be examined to determine the shor short term sustainability of a company company. If cash is increasing (and operational cash flow is positive), then a company will often be deemed to be healthy in the short term. Increasing or stable cash balances suggest that a company is able to meet its cash needs, and remain solvent. For instance, a company may be generating profit, but still have difficulty in remaining solvent.

Example of a cash flow in '000s Transaction Incoming Loan Sales (paid for in cash) Materials Labour In (Debit) Out (Credit) +50.00 +30.00 -10.00 -10.00

Purchased Capital Loan Repayment Taxes Total

-10.00 -5.00 -5.00 +40.00

Therefore 40,000 is available for investment and other activities; it is the net cash flow. An enterprise has to pay trade creditors before anyone else and then pay for other costs. Therefore Net cash flow = Accounts receivable - (Accounts payable + other costs)