BANK LOANS

As per Riddhi Siddhi Multi Services, the simplest and most common source of short-term finance is an unsecured loan from a bank. Lines of credit are typically reviewed annually, and it is possible that the bank may seek to cancel it if the firm’s creditworthiness deteriorates. If the firm wants to be sure that it will be able to borrow, it can enter into a revolving credit agreement with the bank. Revolving credit arrangements usually last for a few years and formally commit the bank to lending up to the agreed limit.

Most bank loans have durations of only a few months. However, banks also make term loans, which last for several years. These term loans sometimes involve huge sums of money, and in this case they may be parceled out among a syndicate of banks.

COMMERCIAL PAPER

When banks lend money, they provide two services. They match up would-be borrowers and lenders and they check that the borrower is likely to repay the loan. Banks recover the costs of providing these services by charging borrowers on average a higher interest rate than they pay to lenders. These services are less necessary for large, well known companies that regularly need to raise large amounts of cash. These companies have increasingly found it profitable to bypass the bank and to sell short-term debt, known as commercial paper, directly to large investors. Banks have been forced to respond by reducing the interest rates on their loans to blue-chip customers.

Riddhi Siddhi Multi Services financial experts do not consider commercial paper secure, but companies generally back their issue of paper by arranging a special backup line of credit with a bank. This guarantees that they can find the money to repay the paper, and the risk of default is therefore small.

SECURED LOANS

Many short-term loans are unsecured, but sometimes the company may offer assets as security. Since the bank is lending on a short-term basis, the security generally consists of liquid assets such as receivables, inventories, or securities. For example, a firm may decide to borrow short-term money secured by its accounts receivable. When its customers pay their bills, it can use the cash collected to repay the loan. Banks will not usually lend the full value of the assets that are used as security.

Accounts Receivable Financing.

When a loan is secured by receivables, the firm assigns the receivables to the bank. If the firm fails to repay the loan, the bank can collect the receivables from the firm’s customers and use the cash to pay off the debt. However, the firm is still responsible for the loan even if the receivables ultimately cannot be collected. The risk of default on the receivables is therefore borne by the firm.

An alternative procedure is to sell the receivables at a discount to a financial institution known as a factor and let it collect the money. In other words, some companies solve their financing problem by borrowing on the strength of their current assets; others solve it by selling their current assets. Once the firm has sold its receivables, the factor bears all the responsibility for collecting on the accounts. Therefore, the factor plays three roles: it administers collection of receivables, takes responsibility for bad debts, and provides finance. You can ask Riddhi Siddhi Multi Services consultants to get better understanding of these aspects.