Methods of Raising Short-Term Finance Part 3

Download PDF of This Page (Size: 166K)

There are a number of methods used for raising short-term finance. These are:

  • Trade credit

  • Bank credit

  • Loans and Advances

  • Cash Credit

  • Bank Overdraft

  • Discounting of Bills

  • Factoring

  • Customers’ Advances

  • Instalment Credit

  • Loans from Unorganised sectors

Trade Credit

Trade credit refers to credit granted to manufacturers and traders by the suppliers of raw material, finished goods, components, etc. Usually business enterprises buy goods on 30 to 90 days credit. This means that the goods are delivered but payments are not made until the expiry of the period of credit. This type of credit does not make the funds available in cash but it facilitates purchases without making immediate payment which amounts to funding it by suppliers. This is a very popular source of short-term finance.

Bank Credit

Commercial banks usually provide short-term finance to business firms, which is known as bank credit. When bank credit is granted, the borrower gets a right to draw the amount of credit as and when needed. Bank credit may be granted in any of the following ways:

Loans and Advances

When a certain amount of money is advanced by a bank repayable after a specified period, it is known as bank loan. Such advance is credited to a separate loan account and the borrower has to pay interest on the whole amount of loan irrespective of the amount of loan actually drawn. Usually loans are granted against security of assets.

Cash Credit

It is an arrangement whereby banks allow the borrower to withdraw money up to a specified limit. This limit is known as cash credit limit. This facility is granted against the security of goods in stock or promissory notes or other marketable securities like government bonds. Under this arrangement, the borrower can draw, repay and again draw the amount within the sanctioned limit. Interest is charged only on the amount actually withdrawn and not on the amount of entire limit.

Bank Overdraft

When a bank allows its depositors or accountholders to withdraw money in excess of the balance in his current deposit account up to a specified limit, it is known as overdraft facility. This limit is granted purely on the basis of credit worthiness of the borrower. Interest is charged only on the overdrawn money. Rate of interest in case of bank overdraft is less than the rate charged under cash credit.

Discounting of Bill

Banks also give advance money by discounting bill of exchange. When a bill of exchange is presented before the bank for encashment, bank credits the amount to customer’s account after deducting some discount. The amount of discount is charged on the basis of the interest for the period of bill. On maturity of the bill, the payment is received by the bank from the drawee.

Factoring

Factoring is a method of raising short-term finance for the business in which the business can take advance money from the bank against the amount to be realised from the debtors. By this method, the firm shifts the responsibility of collecting the outstanding amount from the debtors on payment of a specified charge. Here the business gets the money in advance without waiting for due date. Also, it saves the effort of collecting the debts.

Customers’ Advances

Sometimes businessmen insist to their customers to make some advance payment. It is generally asked when the value of order is quite large or goods ordered are very costly. Customers’ advance represents a part of the payment towards sale price of the product(s), which will be delivered at a later date. Customers generally agree to make advance payment when such goods are not easily available in the market or there is an urgent need of any goods. A firm can meet its short-term requirements with the help of customers’ advances.

Loans from Unorganised Sectors

In addition to the above methods of raising funds, the businessmen always have the option to take the money from the unorganised sector like loans from the moneylender (called indigenous bankers), friends and relatives. To meet the short-term and urgent need of business, money can be obtained from them either on personal security or on security of tangible assets and personal properties. Since the interest charged on loans from unorganised sector is normally very high, the businessmen are not very keen to avail of loan from this source.

Types of Security Required for Obtaining Bank Credit

We learnt that loans and advances are granted by the banks on the basis of some security, which will ensure the bank for safe return of its money. This security may be personal security of the borrower as well as on the security of some assets, besides the standing of the firm. Thus, securities offered against bank credit may be of two types:

  • Personal security

  • Security of assets

Personal security means the credit-worthiness of the borrower. Banks judge the creditworthiness of the borrower on the basis of his financial soundness and past dealings with the bank, and then sanction the amount. When the banks ask for security of assets, the following are generally accepted as security for extending short-term finance.

Moveable Goods

Stock of raw materials and finished goods are accepted by banks as security against bank credit. In case of non-payment, these goods are sold and money is recovered by banks.

Shares

Shares that are quoted on a recognised stock exchange are accepted as security against bank credit. The borrower is required to assign his shareholding in favour of the bank.

Documents of Title to Goods

Bill of Lading, Railway Receipts (RR), Goods Receipt (GR), Warehouse warrant are various documents which are recognised as documents of title to goods. To secure credit from bank, the borrower may deposit any of these documents with bank after duly endorsing the same in favour of the bank. This enables the bank to deal with the goods in case of default in repayment.

Fixed Deposit Receipts

It is a receipt issued by bank as evidence of fixed deposit made by the customer. Banks grant loan on the security of this receipt. Banks normally grant loan up to 90% of the value of such receipts.

Life Insurance Policies

Banks extend credit on the basis of life insurance policy up to the amount of surrender value of such receipts.

Jewellery or Precious Metals

This type of security may be offered to borrow money for private as well as for business purposes. Sole proprietary concerns sometimes offer jewellery or other precious metals to obtain credit

Other Securities

Besides the assets and documents mentioned above, banks also accept National Savings Certificate (NSC), Kisan Vikas Patra (KVP), Government Bonds for grant of short-term credit.

Developed by: