sources of short term finance

2. Sources of Short-term Finance
Short term finance in business usually refers to the
additional money a business requires for doing its
business for short terms, which is usually a
maximum period of one year. Some main sources of
short term finance are:-
1. Trade Credit
2. Bridge Finance
3. Loans from Commercial Banks
4. Commercial Papers (CPs)
5. Inter-corporate Deposits (ICDs)

3. • Trade Credit:- Trade credit refers to purchasing goods and services a business need in
the course of its business on credit. Depending on the trade practices prevalent in an
industry, the credit worthiness of the company, and nature of business relationship
between company and its suppliers a company may be allowed different time
periods to pay for the goods and services they buy from different suppliers.
• Bridge Finance:- Bridge finance refers to loans taken by a company normally from
commercial banks for a short period, pending disbursement of loans sanctioned by
financial institutions. As the term implies, these loans "bridge the gap" between
times when financing is needed. Usually this they of loan is short-term loan that is
used until a person or company secures permanent financing or removes an existing
obligation. This type of financing allows the user to meet current obligations by
providing immediate cash flow. Generally, the rate of interest on bridge finance is
higher as compared with that on term loans.
• Loan from commercial bank:- Commercial banks grant 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 at one time or in installments as
and when needed. Bank credit may be granted by way of loans, cash credit,
overdraft and discounted bills.

4. • Commercial paper:- commercial paper is an unsecured promissory note with a
fixed maturity of no more than 270 days. Commercial paper is a money-market
security issued by large corporations to get money to meet short term debt
obligations, and is only backed by an issuing bank or corporation's promise to pay
the face amount on the maturity date specified on the note. Since it is not backed
by collateral, only firms with excellent credit ratings from a recognized rating
agency will be able to sell their commercial paper at a reasonable price.
Commercial paper is usually sold at a discount from face value, and carries higher
interest repayment rates than bonds.
• Inter-corporate Deposits (ICDs):- A deposit made by one firm with another firm is
known as Inter-corporate Deposits (ICDs). Generally, these deposits are usually
made for a period up to six months. Such deposits may be of three types:
1. Call Deposits
2. Three Months Deposits
3. Six Months Deposits

5. Venture Capital Financing
• The venture capital financing refers to financing of new high risky venture
promoted by qualified entrepreneurs who lack experience and funds to give shape
to their ideas. In a broad sense, under venture capital financing, venture capitalists
make investments to purchase equity or debt securities from inexperienced
entrepreneurs, who undertake highly risky ventures with a potential of success.
Methods of Venture Capital Financing
1. Equity financing
2. Conditional loan
3. Income note
4. Participating debenture

6. Leasing and Hire Purchase as a Source of Finance
• A lease is a contractual arrangement under which the owner of an asset (called
the lessor) agrees to allow the case of its asset by another party (lessee) in
exchange of periodic payments (lease- rental) for a specified period. The lessee
pays the lease rent as a fixed payment over a period of time at the beginning or
at the end of a month, quarter, half year or year. Although generally fixed, lease
rents can be tailored both in terms of amount and tuning to the profits and
cash flow position of the lessee.
Advantages of leasing
• To buy a new piece of machinery or equipment can be costly and requires
substantial capital. Leasing enables businesses to preserve precious cash
reserves.
• The smaller, regular payments required by a lease agreement enable businesses
with limited capital to manage their cash flow more effectively and adapt
quickly to changing economic conditions.
• Leasing also allows businesses to upgrade assets more frequently ensuring they
have the latest equipment without having to make further capital outlays.
• It gives businesses certainty because asset finance agreements cannot be
cancelled by the lenders and repayments are generally fixed.
• It is easy to access because it is secured – largely or entirely – on the asset
being financed, rather than on other personal or business assets.

7. Disadvantages of leasing
1. Risk of being deprived of the use of equipment of the lessors
(owners) financial condition worsens, or if the leasing company is
worried up, the lessee may be deprived of the use of the equipment
thus disrupting normal manufacturing operations.
2. Alteration/change in the asset: Under the lease, the lessee is
generally prohibited from making alterations/improvements on the
leased asset without the prior approval of the lessor (the owner).
3. Terminal value of the asset: In case of assets (such as land and
buildings), which have high terminal value at the end of the lease
term, it would be more appropriate to own the asset than to lease
it.
4. To make lease payments even if the asset has become obsolete. If a
lessee leases an asset that subsequently becomes obsolete, it still
must make lease payments over the remaining term of the lease.
This is true even if the asset is unsalable.

8. Hire Purchase
• Very similar to leasing is hire purchase except
that in hire purchase, the ownership will be
transferred to the buyer after all the hire
purchase installments are paid up. With many
non-banking finance companies offering the
leasing and hire purchase of
equipments, many companies are opting for
this route to finance their fixed assets.

9. Deferred Credit
• The deferred credit facility is offered by the
suppliers of machinery, whereby the buyer
can pay the purchase price in installments
spread over a period of time. The interest and
repayment period are negotiated between the
supplier and the buyer.

10. Capital Assistance Seed
• The seed capital assistance scheme is designed by IDBI for
professionally or technically qualified entrepreneurs and/or
persons possessing relevant experience, skills and
entrepreneurial traits. The project cost should not exceed 2
crores and the maximum assistance under the project will
be restricted to 50% of the required promoters contribution
or 15 lacs whichever is lower.
• The seed capital assistance is interest free but carries a
service charge of 1% for the first five year and 10% p.a.
thereafter. However, IDBI will have the option to change
interest at such rate as may be determined by IDBI based on
the financial position and profitability of the company. The
repayment schedule is fixed depending upon the repaying
capacity of the unit with an initial moratorium up to five
years.

11. Government Subsidy
The central and state governments provide subsidies to
industrial units located in backward areas. The central
government has classified backward areas into three categories
of districts: A, B and C. The central subsidies applicable to
industrial projects in these districts are:
1. Category A Districts-25% of the fixed capital investment
subject to a maximum of 25 lakhs
2. Category B Districts-15% of the fixed capital investment
subject to a maximum of 15 lakhs
3. Category C Districts-10% of the fixed capital investment
subject to a maximum of 10 lakhs

12. Sales Tax Deferments and Exemptions
To attract industries, the state provides incentives, in the form
of sales tax deferments and sales tax exemptions. Under the
sales tax deferment scheme, the payment of sales tax on the
sale of finished goods may be deferred for a period ranging
between five to twelve years. Essentially, it implies that the
project gets an interest-free loan, represented by the quantum
of Sales Tax deferment period.