Sources of Finance - Short term and Long Term

SOURCES OF FINANCE

Sources of Short term and long term finance

The business requires two types of finance namely: 

1.Short term finance

2.Long term finance. 

Short term finance is concerned with decisions relating to current assets and current liabilities and is also called as working capital finance.Short term financial decisions typically involve cash flows within a year or within the operating cycle of the firm. Normally short term finance is for a period up to 3 years.

The main sources of short term finance are:
1. Cash credit

2. Short term loans from financial institutions

3. Bill Discounting

4.Letter of credit

5.Inter-corporate deposits

6.Commercial papers

7. Factoring

8. Working capital advance by commercial banks

1. Cash Credit:Cash Credit facility is taken basically for financing the working capital requirements of the organization. Interest is charged the moment cash credit is credited to the Bank A/C irrespective of the usage of the Cash Credit.

2. Short term loans from financial institutions: Bank overdraft

3. Bill Discounting:Bill Discounting is a short term source of finance, whereby Bills Receivable received from debtors is in cashed from the bank at a discounted rate.

4. Letter of credit Letter of credit is an indirect form of working capital financing and banks assume only the risk, the credit being provided by the supplier himself.A letter of credit is issued by a bank on behalf of its customer to the seller. As per this document, the bank agrees to honor drafts drawn on it for the supplies made to the customer. I f the seller fulfills the condition laid down in the letter of credit.

5.Inter- corporate Deposits A deposit made by one company with another, normally for a period of six months is referred to as an ICD ie. Short-term deposits with other companies are a fairly attractive form of investment of short term funds in terms of rate of return.These deposits are usually of three types:a.Call deposits: A call deposit is withdraw able by the lender on a given days notice.b.Three-months Deposits: These deposits are taken by the borrowers to tied over a short term cash inadequacy c.Six-month Deposits: Normally lending companies do not extend deposits beyond this time frame. Such deposits are usually made with first-class borrowers.

6. Commercial papers A company can use commercial papers to raise funds. It is a promissory note carrying the undertaking to repay the amount or/ on after a particular date.

7. Factoring A factor is a financial institution which offers services relating to management and financing of debts arising form credit sales. Factoring provides resources to finance receivables as well as facilitates the collection of receivables.There are 2 banks, sponsored organizations which provide such services:

a.SBI factors and commercial services LTD 

b.Canbank factors LTD, started operations since the beginning of 1997. 

8. Working capital advance by commercial banks 


Since the above sources do not permit the use of funds, for a longer period of time, the business has to seek further sources, if the need is for a longer period of time, i.e. This extends up to 3 years and above.When a firm wants to invest in long term assets, it must find the needs to finance them. The firm can rely to some extent on funds generated internally.However, in most cases internal resources are not enough to support investment plans. When that happens the firm may have to curtail investment plan or seek external funding. Most firms choose to take external funding.They supplement internal funding with external funding raise from a variety of sources.


The main sources of long term finance can broadly divided into:

Internal sources include:

a.Share capital (Equity shares and preference shares)b.Reserves and Surplus c.Personal loans and advances from owners called as ‘Quasi Capital’

External sources include:

a.Term loan from banks, financial institutions and international bodies like International Monetary Funds, World Bank, Asian Development Bank. b.Debentures 

c.Loans and advances from friends and relatives

 d.Inter- Corporate Deposits

 e.Asian Depository Receipts / Global Depository Receipts

f.Commercial Papers.The short term or long term finance is a function of financial management.The good and efficient management is that which can raise the funds whenever required and at the most competitive terms and conditions. Raising of funds either internally or externally requires a professional approach and also complying with so many legal, technical and statutory requirements prescribed by the Companies Act, Securities Exchange Board Of India, Stock Exchanges Authorities and also allied laws like Income Tax, Foreign Exchange Management Act, Banking Regulations Act, etc.