Definition of All the Terms Associated with Short-Term Financing
If a company determines that it does not have enough funds coming from its assets to cover its current liabilities and any unexpected costs that may arise, short-term financing is a viable option. Common methods of short-term financing include factoring, bank loans, a line of credit, trade credit, and customer advances.
Many companies work with factors to use advance factoring. A factor is an agent, usually a third-party financial institution, who purchases a company's accounts receivable at a discount. Advance factoring, or factoring, is a financial service wherein a factor advances payment to a company to purchase its accounts receivable prior to maturity minus the factor's commission; it can be done with or without recourse. Recourse factoring is a financial service in which a factor purchases a company's accounts receivable but requires the company to buy back any unpaid receivables. Thus, the risk remains with the company when factoring is done with recourse. If the factoring is done without recourse, the factor assumes the risk for any unpaid receivables, as the company is not required to buy back any unpaid receivables. Another type of short-term financing is a more traditional revolving line of credit such as a credit card, which is a way for a business to borrow money on an ongoing basis up to a certain predetermined amount.Other common forms of short-term financing include trade credit and customer advances. Trade credit is an informal business-to-business agreement where a company can purchase a good or service without paying the supplier up front. The supplier is paid at a later date, usually 30, 60, or 90 days after the initial purchase date. The terms for trade credit are reached by an agreement between the companies involved. Trade credit provides time for companies to sell their inventory to repay the supplier or to use their available cash flow for other purposes. Trade credit also benefits the supplier because the supplier can control the terms of the agreement, such as price and repayment terms. On the other hand, a customer advance occurs when the customer pays up front for a product or service before actually receiving the product or service. Customer advances are common when companies receive large orders, especially for product releases concerning pre-orders, and money is provided in advance so the company can fund its operations.
Overview of Short-Term Financing
Calculation of Simple and Compound Interest
Determining the simple interest charge on a transaction requires a straightforward calculation. Simple interest is calculated by multiplying the daily interest rate by the principal, the initial amount that was borrowed and still needs to be paid off, and by the number of days elapsed between payments. For example, Big Systems Inc. has a savings account bank balance of $30,000. The bank will give Big Systems Inc. 7 percent interest every year. The balance in Big Systems Inc.'s account after a year would be $32,100, of which $2,100 is the interest earned.Simple interest for the first year can be calculated.
Typically, simple interest is used for short-term personal loans and in short-term financing. This type of interest benefits consumers who pay their loans on time or early each month. It is better to pay the loans back on time or early so that more of the payment applies to the principal rather than to the interest. Compound interest is the result of reinvesting interest rather than paying it out, so that interest in the next period is then earned on the principal sum plus previously accumulated interest.