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Ultimate Guide to Short Term Sources of Finance

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MSMEs are experiencing a boom in India today. This growth calls for financing options that fit the fast pace and unique challenges arising in this situation. Sometimes, navigating through your financial options can feel like searching for water in a desert—especially when immediate needs arise. That’s where short-term sources of finance come into play.

 

In this blog, we’ll explore different short-term financing options designed to enhance your liquidity, manage cash flows, and keep your business operations smooth. Whether grappling with unexpected expenses or trying to bridge a gap until your next big payment, they can be pivotal. So, let’s dive in and discover how these short-term sources of finance can help your business stay agile and thrive in a competitive landscape.

 

What is short-term finance?

 

Short-term finance refers to sources of funding designed to meet a business’s immediate financial needs. Entrepreneurs typically use it to bridge gaps in cash flow, manage unexpected expenses, or take advantage of timely business opportunities. 

 

Their primary purpose is to provide liquidity to businesses so that they can continue operating smoothly without financial interruptions. It can assist in covering short-term expenses such as payroll, inventory purchases, and other operational costs. 

 

Short-term finance rarely goes beyond a year. This limited time frame allows businesses to manage cash flow effectively without committing to long-term financial obligations. 

 

Example of short-term finance

 

We shall take an example to set up some context. A retail clothing store needs to increase its inventory for the upcoming holiday season. The store owner can opt for a short-term loan to purchase additional stock. By securing a loan that matures in three to six months, the owner can pay for the inventory, sell the goods during the holiday rush, and repay the loan with the revenues from these sales. This cycle of borrowing, spending, and repaying is typical in businesses that have seasonal sales patterns. It allows them to stay financially fluid without impacting long-term liabilities.

 

Short-term sources of finances you can avail for your business

 

Short-term sources of finance play a pivotal role in supporting businesses. Below is a comprehensive list of the common options available designed to provide flexibility for handling day-to-day business challenges:

 

Trade credit:

Trade credit is a form of short-term finance where suppliers allow businesses to purchase goods or services and pay for them at a later date. This delay in payment provides businesses with the flexibility to manage their cash flow more effectively. For example, a small bakery might receive flour and sugar from suppliers on trade credit, enabling it to produce and sell goods before needing to settle the supplier invoices within 30 to 90 days.

 

Bank overdrafts:

A bank overdraft allows businesses to withdraw more money from their bank account than they have available, up to a pre-agreed limit. This is useful for covering short-term cash shortages. For instance, if a company faces unexpected expenses like emergency repairs, it can use an overdraft to cover these costs temporarily without needing to secure a formal loan.

 

Short-term loans:

Short-term loans are borrowed funds that must be repaid within a year. These are typically used to address sudden financial needs or opportunities. For example, a technology startup might take a short-term loan to purchase essential equipment for a new project, planning to repay the loan from the project’s earnings within several months.

 

Commercial paper:

Commercial paper is an unsecured, short-term debt instrument issued by large corporations to finance their immediate operational needs, such as payroll or inventory purchases. Companies with high credit ratings generally use commercial paper. A large manufacturing company issuing commercial paper to fund its inventory needs quickly without the need for collateral.

 

Factoring:

Factoring is one of the short-term sources of finance that involves a business selling its receivables (invoices) to a third party (a factor) at a discount. This provides the enterprise with immediate cash and transfers the responsibility of collecting the payment to the factor. For instance, a textile manufacturer might use factoring to convert sales made on credit terms into immediate cash, helping to ease cash flow pressures.

 

Credit lines:

A line of credit is a flexible loan from a bank or financial institution that sets a maximum loan balance that the borrower can access. The business can draw from the line of credit at any time, as long as it does not exceed the maximum set. For example, a landscaping company might use a line of credit to buy plants and materials throughout the landscaping season and pay back the balance as it earns revenue from completed projects.

 

Benefits of short-term sources of finance

 

To fully unlock the potential of short-term sources of finance, it’s important to understand the unique benefits they offer. These financial tools not only provide quick access to funds but also allow businesses to maintain flexibility. It can even minimise long-term commitments and improve overall cash flow management. Here’s how each of these advantages plays a crucial role in sustaining and growing a business:

 

Quick access to funds:

Short-term sources of finance provide businesses with the ability to access funds quickly when needed. This rapid financing is crucial for dealing with unforeseen expenses or taking advantage of timely opportunities. For example, if a restaurant suddenly needs to replace a broken refrigerator, obtaining a short-term loan or using an overdraft can solve the problem immediately, ensuring the business continues to operate smoothly without significant downtime.

 

Flexibility in usage:

Short-term finance offers significant flexibility, allowing businesses to use the funds for a variety of purposes without strict conditions. This versatility is particularly beneficial for businesses that face varying operational demands. For instance, a retailer could use a line of credit to increase inventory before a high-demand season and then reduce usage after the season ends, adapting their financing to their immediate needs.

 

Minimal long-term commitment:

Engaging with short-term financing options means businesses are not tied down with long-term debt obligations. This is advantageous for maintaining financial freedom and adaptability. A small tech firm, for instance, might prefer short-term loans to fund occasional software upgrades, avoiding the long-term financial burden and interest costs associated with more extended credit arrangements.

 

Improved cash flow management:

Short-term sources of finance help businesses manage their cash flow more effectively by providing immediate financial relief when revenues are low or expenses are high. By using facilities like factoring, a company can convert outstanding invoices into cash immediately rather than waiting for client payments. This immediate liquidity helps smooth out the financial operations and ensures that the business can cover its short-term obligations without stress.

 

Harness the power of short-term sources of finance today

 

The strategic use of short-term finance can profoundly impact business agility and financial stability. By exploring and implementing solutions like trade credit, bank overdrafts, short-term loans, commercial paper, factoring, and credit lines, businesses can navigate cash flow challenges and seize opportunities with unprecedented flexibility. 

 

Understanding short-term finance types allows companies to manage their finances more effectively. It also encourages them to proactively seek customised financial tools. As businesses continue to evolve, the thoughtful application of short-term financial solutions is key to fostering growth and ensuring sustainability in a dynamic economic landscape.

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