CHAPTER 7

SOURCES OF SHORT-TERM
CAPITAL
Presented By : Group 5

Business Finance| 2024

 LEARNING OBJECTIVES

• To know the advantages and disadvantages of short-

term credits
• To identify the suppliers of short-term funds

1
 OVERVIEW
• Advantages of • Trade Creditors • Factors
Short-term Credits
• Commercial Banks • Insurance Companies
• Disadvantages of
Short-term Credits • Company Accruals
• Commercial Paper
Houses
• The Suppliers of
Short-term Funds • Finance
Companies
2
The total business finance function is composed of three segments:
(1) short-term financing, (2) intermediate-term financing, and (3)
long-term financing.

Short-term financing deals with the demand for and supply of short-
term funds which may either be secured or unsecured.

3
 ADVANTAGES OF SHORT-TERM
CREDITS
1. They are easier to obtain.
2. Short-term financing is often less costly.
3. Short-term financing offers flexibility to the
borrower.

4
 DISADVANTAGES OF SHORT-TERM
CREDITS

1. Short-term credits mature more frequently.

2. Short-term debts may, at times, be more costly than
long- term debts.

5
 THE SUPPLIERS OF
SHORT-TERM FUNDS
1. TRADE CREDITORS;
2. COMMERCIAL BANKS;
3. COMMERCIAL PAPER HOUSES;
4. FINANCE COMPANIES;
5. FACTORS;
6. INSURANCE COMPANIES; AND
7. COMPANY ACCRUALS.
6
 TRADE CREDITORS
1 • Suppliers extending credit to a buyer for use in
manufacturing, processing, or reselling goods, for
profits are called trade creditors.
• Credit extended by trade creditors in short-term is
usually unsecured, and is known as trade credit,
3 commercial credit, mercantile credit, or accounts
receivable credit.
7
 NATURE OF TRADE CREDIT
Trade credit is a form of credit extended by a firm to another firm. When the
credit is extended to a final consumer it no longer quantifies as trade credit but
as consumer credit.

Also, when credit is extended to a firm in the purchase of machinery and

equipment and secured by the equipment sold, it no longer qualifies as trade
credit but as installment credit.

Trade credit appears in the book of accounts of the creditor as accounts or notes
receivable. In the book of the debtor, it appears as accounts or notes payable.
8
 TRADE CREDITS
INSTRUMENTS
• Open-book Credit
• Trade Acceptance
• Promissory Note
9
 OPEN-BOOK CREDIT
Open-book credit constitutes the bulk of trade credit. It is unsecured
and it permits the customer to pay for goods delivered to him in a
specified number of days.

The open-book credit as a form of financing reduces the amount of

funds that the manager must raise from other sources. For most of
the financially weak small firms, the open-book credit is a welcome
source of inventory financing.
10
 TRACE ACCEPTANCE
The trade acceptance is a time draft drawn by a seller upon a
purchaser, payable to the seller as payee, and accepted by the
purchaser as evidence that the goods shipped are satisfactory and
that the price is due and payable. A buyer who honors the term of the
trade acceptance improves his credit standing and may later qualify
for open-book credit.

11
 PROMISSORY NOTE
The promissory note is an unconditional promise in writing made by
one person to another, signed by the maker, engaging to pay on
demand or at a fixed or determinable future time, a sum certain in
money to, or to the order of, a specified person, or to bearer. This
credit instrument is given to the creditor by a buyer who has a weak
credit position.

12
 THE PROMISSORY NOTE HAS TWO
ADVANTAGES:

1. the time and the amount of payment are indicated, avoiding

litigation over such matters; and
2. promissory notes may be endorsed to other parties allowing
the creditor immediate use of funds tied up in such credit
arrangement.

13
 COST OF TRADE CREDIT
Firms which extend trade credit normally provide incentive to firms which settle their
accounts early. The Incentive takes the form of a discount like a five percent deduction
from the price indicated in the invoice if settled within five days. The firm that does not
avail of the trade discount incurs a cost related to the trade credit. This cost may be
computed as follows:

14
 COMMERCIAL BANKS
Commercial banks are institutions which individuals or firms may tap as source of
short-term financing. In the strict sense, commercial banks are corporations which
accept or create deposits subject to withdrawal by check.

Originally, the banking system is composed of four highly distinctive components

consisting of the following:
1. commercial banks;
2. development banks
3. savings banks and
4. rural banks.
15
 TYPES OF SHORT-TERM LOANS

Short-term loans, as distinguished from intermediate-term and long-term

loans, are those with maturity periods of one year or less. Short-term loans
are generally offered by commercial banks for purposes which include the
financing of business activities.

Short-term loans are classified into two types:

(1) unsecured; and
(2) secured
16
 TYPES OF SHORT-TERM LOANS
• Unsecured loans, also called clean loan, are those which do not require
collateral.

• Secured loans are those which require a collateral back-up. A collateral

is usually required when the credit standing of the borrower is
inadequate to permit unsecured loans.

17
 COMMERCIAL PAPER HOUSES
The commercial paper is a short-term promissory note, generally unsecured and
which is sold through commercial paper dealers or directly to investors. Commercial
papers are issued by finance companies and business firms that borrow funds in the
money market.

Firms that buy commercial papers are called commercial paper houses (CPH). In
effect, they finance the short-term fund requirements of borrowing firms. Commercial
paper houses include banks and other financial institutions, like those engaged in
selling insurance, educational, pension, and mortuary plans.

18
 FINANCE COMPANIES
Finance companies are those which are engaged in making short and
intermediate term installment loans to consumers, factor or finance
business receivables, and finance the sale of business and farm
equipment. Funds are raised by finance companies, just like any other
corporation, by issuing stocks and bonds, borrowing from banks, and
selling their commercial papers.

19
 TYPES OF FINANCE
COMPANIES
1. Sales finance companies;
2. Business or Commercial finance
companies; and
3. Personal finance companies.

20
 SALES FINANCE COMPANIES

Sales finance companies are firms specializing in the

purchase from retailers of the installment receivables arising
out of retail sales of automobiles, household appliances,
industrial equipment, farm equipment, and other durable
goods sold on the installment payment plan.

21
 BUSINESS/COMMERCIAL FINANCE
COMPANIES
Business or commercial finance companies lend directly to a wide variety of
businesses, mainly of small and medium size. Short-term loans are granted by
this type of finance companies against the security of assigned accounts
receivables, inventory, and equipment.

When using accounts receivables as collateral, the loan arrangement may be

considered under any of the following:
1. non-notification plan; or
2. notification plan. 22
 BUSINESS/COMMERCIAL FINANCE
COMPANIES
Under the non-notification plan, the debtors of the
borrowing firm are not aware that their accounts have been
pledged as collateral for a loan from a finance company.
When the debtors are informed, the plan is of the
notification type.

23
 PERSONAL FINANCE COMPANIES

Finance companies which are personal loans are called

personal finance companies. Their loan portfolio, however,
may include miscellaneous business loans and commercial
accounts receivable loans.

24
 FACTORS
Factors perform the financial service known as factoring, which consists of
the purchase of accounts receivables outright without recourse to the seller
for credit losses.

Factoring provides some advantages to the borrowing firm:

1. Receivables provide collateral for a loan that might not be otherwise
available to the firm; and
2. Accounts receivable financing provides flexibility to the firm.

25
FACTORS

26
 INSURANCE COMPANIES

Insurance companies provide a stable source of

short-term funds.
Insurance companies normally invest on short-term
commercial papers and promissory notes.

27
 COMPANY ACCRUALS
An accrual is an expense that has been incurred but has not yet been paid.
Accruals provide a source of short-term financing for business firms. There
are two major forms of accruals: (1) accrued wages and salaries; and (2)
accrued taxes.
1.Accrued salaries and wages ought to be paid as soon as they are
rendered. This does not happen, however, and the delay in actual
Payment gives the firm a source of short-term financing.
2.Accrued taxes normally take a longer time lag before payment becomes
due.

28
 Business Finance | 2024

THANK YOU!
Presented By : Group 5