SOURCES OF SHORT-TERM AND MEDIUM-TERM FUNDS
April 27, 2010
Short-term funds are usually for up to three years or less while medium-term loans are for about three years to five years.
1. Bank Lending
This is usually a short-term loan for up to 3 years and an overdraft. Interest on a bank overdraft is charged at a variable rate on the amount by which the company is overdrawn from day to day. The limit of the overdraft is set by the bank.
2. Leasing Transactions
a) Sale and Leaseback – This is where a company obtains finance by selling its property e.g. A building and renting it back.
b) Operating Leases– These are rental agreements between a lessor and a lessee whereby:
i) The lessor who owns a capital asset supplies the asset e.g. Equipment to the lessee and is responsible for servicing and maintaining the leased equipment.
ii) The lessee makes payments under the terms of the lease to the lessor for a specified period of time which is less than the economic life of the asset.
iii) At the end of the lease period, the lessor takes back his asset and can lease it to another person or sell the asset second-hand.
NB – Assets under operating leases do not have to be shown in the lessee’s balance sheet.
i) Lessee is responsible for servicing and maintenance of the asset.
ii) Lease has a primary period which covers all or most of the useful economic life of the asset
iii) At the end of the primary period, the lessor can allow the lessee to keep the asset at a low nominal rent or sell the asset and keep most of the sale proceeds and only pay a small percentage to the lessor.
This is a form of instalment credit where a company or individual purchases goods on credit and pays for them by instalments. These transactions usually involve a finance house that provides funds to purchase a fixed asset on hire purchase.
This is where the government may provide finance in form of grants and other forms to companies especially in high-technology industries. However, this assistance is severely restricted.
5. Foreign Currency Markets (International Borrowing)
These are international markets dealing with foreign currencies. Funds are deposited with a bank outside the country of origin of the funds and the funds are then lent out on a short-term basis eg. 3 months. Most foreign currency lending takes place between banks of different countries and is in the form of negotiable certificates of deposit.
6. Eurobonds
These are bonds issued in European capital markets and are denominated in a currency which often differs from that of the country of issue and sold internationally.
They are long-term loans raised by international companies in several countries at the same time.
7. Commercial Paper
A commercial paper is a short-term financial instrument issued in the form of unsecured promissory notes with a fixed maturity date. A promissory note is a written promise to pay at a fixed future date, the amount shown on the note.
8. Accounts payable (trade credit) and accruals
Accounts payable is a spontaneous source of financing as it arises in the normal course of business. A business can make its purchases on credit and pay later depending on the credit terms given. Accruals are considered to be free as they generally have no interest paid on them. They are deferred and paid later and therefore provide a free source of financing.
9. Retained earnings
Companies can also raise money through retained earnings. These are the undistributed profits
that are retained within the business. The funds are available within the business and can be
utilized in the operations of the business.
1. Short-term loans can be obtained faster than long-term funding.
2. The costs associated with short-term funds are lower than for long-term funding.
3. Short-term credit agreements do not always constrain a firm’s future actions as the long-term funds. I.e. long-term funds may have provisions that constrain a firm from undertaking some actions.
1. Interest costs on long-term loans may be relatively stable or even fixed and can easily be estimated for the future. Short-term interest costs may fluctuate widely and at times be very high. They may easily create a burden for the firm.
2. If a firm borrows heavily on short-term, it may be unable to repay and may be forced into liquidation.
The following factors determine the borrowing:
1. The currency required by the company
2. The cost of finance ie. Interest rates differ and must be considered
3. Timing and speed – it may be possible to raise money faster in foreign currency markets than in a domestic market
4. Security – a company should consider the security provided for loans
5. Size of the loan and size of the company – a large multinational can raise large sums in a foreign currency market easier than a small company.
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