Short term finance is used by businesses to cover the current liabilities such as creditors, expenses. Short term loans in Nigeria are provided by most of the CBN regulated lenders.
Types of short term finance
- Trade credit
It is sometimes possible for a firm to add to its short-term working capital by making the fullest use of the trade credit that suppliers grant. This type of facility can be extended by pre-arrangement to customers who are manufacturing products where there is considerable time lag between buying the raw materials, converting them into finished goods and sellings them.
A lot of businesses benefit from using factoring (it’s a specialist area of banking in its own right) and a similar activity called invoice discounting. The international market for letters of credit is called the ὰ fortait market and is a form of factoring (banks buying debt owed to companies at a discount and recovering the full amount on maturity – allowing the companies to get the bulk of the cash owed to them earlier than they would, so helping their cash flow.
This letter of credit could be sold in the market for immediate value at a discount (to allow for the three months before it could be presented for payment).
- Bill of exchange
A bill of exchange is a promise-to-pay under which a company (the buyer) agrees to pay the seller a given sum of money at some point in the future – usually three months ahead. It’s a sort of post-dated cheque. To make it more acceptable, bills of exchange were endorsed by prominent merchants
- Discount houses and bill brokerage
Discounting is used by businesses of all sizes, from sole traders and family firms up, so we are now approaching the point at which the banking market shades into retail finance.
Discount houses and bill brokerages are sources of short-term finance, bridging the gap between:
- Supplier, who do not wish to part with their goods until they have been paid for ;and
- Buyers of those goods, who understandably do not want to pay for them until they have taken possession of them.
By drawing a bill of exchange on his customer and ensuring it is accepted on the latter’s behalf, the supplier has a negotiable instrument which he can discount with a discount house or bill broker with a small margin deducted from the face value of the bill to cover the incidence of risks, administrative expenses and interest from the date of discount to the due date. Alternatively where the bills bear good names as acceptor, they may be accepted by a bank to support additional bank finance, usually of a bridging nature, pending the maturity of the bill.