Trade credit from suppliers can be a significant source of short term financing for the firm. If the firm has a strict policy regarding its promptness in paying bills, trade credit becomes a spontaneous (or built in) source of financing that varies with the production cycle.
When a cash discount for prompt payment is offered but not taken, the cash discount forgone becomes a cost of trade credit. The longer the period between the end of the discount period and the time the bill, the less the annualized percentage opportunity cost incurred.
Like accounts payable (trade credit from suppliers), accrued expenses represent a spontaneous source of financing. The principal accrued expenses are wages and taxes, and both are expected to be paid on established dates.
Money market credit and short term loans are forms of negotiated (or external) short term financing in the public or private market.
Large, well established, high quality companies sometimes borrow on a short term basis through commercial paper. Commercial paper represents an unsecured, short term promissory note that is sold in the money market. Commercial paper is sold either through dealers or directly to investors. Rather through dealers or directly to investors. Rather than issue â€œstand aloneâ€? paper, a firm may issue â€œbank supportedâ€? paper, in which case of bank guarantees that the obligation will be paid. The principal advantage of commercial paper is that it is generally cheaper than a short term business loan from a commercial bank.
Bankersâ€™ acceptance financing is another type of money market credit. Usually associated with a foreign trade transaction, the acceptance is highly marketable and can be a very desirable source of short term funds.
Short term loans can be divided into two types unsecured and secured.
Unsecured, short term lending is generally confined to commercial bank loans under a line of credit, a revolving credit agreement, or a transaction basis.
Accounts receivable and inventory are the principal assets used to secure short term business loans.
There are a number of ways in which a lender can obtain a secured interest in inventories. With a floating lien, chattel mortgage, or trust receipt arrangement, the inventory remains in the possession of the borrowers.
Instead of pledging receivables, a firm may engage in factoring (selling) receivables to acquire cash. Factoring often relieves the firm of credit checking the cost of processing receivables, collection expenses, and bad debt expenses.
The best combination of alternative sources of short term financing depends on considerations of cost, availability, timing, flexibility, and the degree to which the assets of the firm are encumbered (burdened with legal claims).