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Sources of Short-Term Financing

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  • 0:06 Short-term Financing Defined
  • 0:45 Trade Credit
  • 1:25 Line of Credit
  • 1:59 Short-term Bank Loans
  • 2:39 Credit Cards
  • 3:01 Lesson Summary
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Lesson Transcript
Instructor: Shawn Grimsley
Companies often need to utilize financing to cover shortfalls in cash flow. In this lesson, you'll learn about sources of short-term financing available to companies including trade credit, lines of credit, bank loans and credit cards.

Short-Term Financing Defined

Meet Nathan. He's a small business owner who owns and operates a local coffee shop and Internet café. Nathan has expenses, such as supplies, rent and payroll, that must be paid on a routine basis. Most of the time, Nathan finances these expenses through his business profits. However, like most businesses, Nathan's business has periods of low cash flow, which is a polite way of saying he's sometimes short on cash.

In order to cover his cash flow problems, Nathan needs to turn to a source of money external to his business. He will use short-term financing, which is the use of credit with maturity of one year or less. Let's look at some of Nathan's options for short-term financing.

Trade Credit

Probably the most important credit facility that Nathan and other businesses use is trade credit. Trade credit is extended by a supplier, allowing its customer, like Nathan, to purchase goods on account instead of cash. The buyer pays the supplier at a later date, usually 30, 60 or 90 days after delivery.

For example, Nathan's bulk coffee bean supplier allows him to make a purchase of beans and lets him pay up to 30 days after delivery of the beans. Trade credit often does not involve payment of interest; it is used by suppliers as an inducement for businesses to buy from them. On the other hand, some suppliers will give a discount if the business pays its account early.

Line of Credit

While some of Nathan's suppliers will offer trade credit, some require 'cash on the barrelhead,' which means they will not extend credit. Additionally, some expenses, like rent and utilities, cannot be delayed without serious consequences.

If Nathan is short of cash, he can turn to his line of credit to cover the shortfall. A line of credit is a contractual arrangement between a borrower, like Nathan's business, and a bank where the bank agrees to loan money on an as-needed basis, up to a maximum amount. For example, Nathan might have a $25,000 line of credit at his bank to keep the lights on and the java brewing during a slow month.

Short-Term Bank Loans

When Nathan started his business, he needed to buy some new commercial-grade espresso makers and kitchen appliances for the pastries, soups and sandwiches he makes. He decided to take out a short-term bank loan, which is simply a bank loan that must be paid in full within one year. These loans are often secured by the property purchased with the borrowed funds.

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