Businesses need to consider how they will fund their activities when starting up as well as during their day-to-day operations. Various costs need to be covered, such as equipment, stock and paying bills.
Short-term finance is used to help a business maintain a positive cash flow. For example, it can be used to:
get through periods when cash flow is poor for seasonal reasons, eg during a rainy summer for an ice cream seller
bridge the gap when a large payment is delayed, leaving the business without enough money to pay its bills
provide extra cash to pay for the manufacturing required to meet sudden or unexpected changes in customer orders
Overdrafts are one of the most common forms of finance. However, they should be used carefully and only in emergencies as they can become expensive due to the high interest rates charged by banks.
Common features of a bank overdraft include:
variable interest rates - the cost of borrowing money will change when the interest rate changes
flexibility - a business uses its overdraft only when it needs to, therefore the business will only pay interest when the
overdraft is used
the bank can demand full payment - banks can demand full repayment of an overdraft within 24 hours
Trade credit must be agreed with a supplier and forms a credit agreement with them. This source of finance allows a business to obtain raw materials and stock but pay for them at a later date. The payment is usually made once the business has had an opportunity to convert the raw materials and stock into products, sell them to its own customers, and receive payment.
Common terms and conditions of a credit agreement include:
credit limit - the maximum amount of credit available to the business
credit period - the length of time the business has to pay what is owed, usually 30, 60 or 90 days
frequency of payment - how often payment is required, usually monthly
method of payment - the way in which the business makes payment (eg bank transfer, cheque or card payment)
retrospective discount - a discount given when the business has purchased a certain amount of stock or raw materials