A business undertaking involves various activities. For carrying out these activities and meeting their costs, every business requires funds.
Funds can be used for meeting day to day business expenses, for procurement of raw material, for expansion and diversification plans and so on. Without funds, it is almost impossible to perform business activities for a long period of time.
A company can obtain funds from different sources of finance. Funds may be obtained for a short duration or for a long duration depending on the type of business requirement. For Instance, a company may require a short term loan for making payment to its creditors while it may require a long term loan for purchase of new machinery.
Four Different Sources of Short Term Finance
Credit Obtained from Suppliers
A company procures raw material from different sources. In addition it may require different types of services from time to time. Normally, every company tries to obtain a credit period from its suppliers. This credit period helps a company to pay for raw material and services after a certain period of time. For Instance, a company has purchased raw material of $ 40,000 from a supplier. Supplier offers a credit period of 45 days from the date of invoice. This enables the company to use available funds for short term investments or to meet its other day to day business expenses.
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Short Term Bank Loan
A company may obtain a short term loan from a bank. Loan is generally payable with interest. Period of loan and the interest rate at which the loan is granted is fixed in advance. Interest rate may vary on the basis of duration of the loan. Loans are generally granted against security of any asset.
Bank overdraft Facility
Banks generally allow their customers to withdraw money in excess of the balance available in their account. A limit may be set by the bank on the maximum amount and the maximum period for which such a facility can be availed by the customer.
Further interest on excess amount may be levied only on the expiry of such period. This facility is normally extended to customers who enjoy a good reputation and credit worthiness in the market.
Advance From Customers
Nowadays almost every business prefers to obtain advance payment from customers. Advance is obtained for goods or services to be provided in the near future. This helps the company to meet the costs that may have to be incurred in connection with the production of goods or rendering of services to be provided later on.
For Instance, a company has entered into a contract with a customer for supply of goods. Total cost of goods is $ 35,000. Company may ask the customer to give an advance of 20% ($ 7,000) of the total cost. Also the risk relating to non payment from a customer is reduced up to a certain level by obtaining an advance amount.
Even though it may be a preferred method of doing business, there is a possibility that many customers won’t agree to such a payment term