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Unit 3: Sources of Finance



            3.4 Sources of Short-term Finance                                                     Notes


            3.4.1  Trade Credit

            Trade credit refers to the credit extended by the supplier of goods or services to his/her customer
            in the normal course of business. Trade credit occupies very important position in short-term
            financing due to the competition. Almost all the traders and manufacturers  are required to
            extend credit facility (a portion), without which there is no possibility of staying back in the
            business. Trade credit is a spontaneous source of finance that  arises in  the normal business
            transactions of the firm without specific negotiations (automatic source of finance). In order to
            get this source of finance, the buyer should have acceptable and dependable credit worthiness
            and reputation in the market. Trade credit generally extended in the format open account or
            bills of exchange. Open account is the form of trade credit, where supplier sends goods to the
            buyer for the payment to be received in future as per terms of the sales invoice. As such trade
            credit constitutes a very important source of finance; it represents 25 per cent to 50 per cent of the
            total short-term sources for financing working capital requirements.
            Getting trade credit may be easy to the well-established or well-reputed firm, but for a new or
            the firm with financial problems will generally face problem in getting trade credit. Generally
            suppliers look for earning record, liquidity position and payment record which is extending
            credit. Building  confidence in suppliers is  possible only when the buyer discussing his/her
            financial condition future plans and payment record. Trade credit involves some benefits and
            costs.

            Advantages of Trade Credit
            The main advantages are:

            1.   Easy  availability when  compared to other sources of finance  (except financially weak
                 companies).
            2.   Flexibility is another benefit, as the credit increases with the growth of the firm’s sales.

            3.   Informality as we have already seen that it is an automatic finance.
            The above discussion on trade credit reveals two things. One, cost of trade credit is very high
            beyond the cash discount period, company should not have cash discount for prompt payment
            and second, if the company is not able to avail cash discount it should pay only at the end of
            last day of credit period, even if it can delay by one or two days, it does not affect the credit
            standing.

            3.4.2  Bridge Finance
            Bridge finance refers to loans taken by a company normally from commercial banks for a short
            period, pending disbursement of loans sanctioned by financial institutions. Normally, it takes
            time  for financial  institutions to disburse loans  to companies. However, once  the loans  are
            approved by the term  lending institutions, companies, in  order not  to lose further time  in
            starting their projects, arrange short-term loans from commercial banks. Bridge loans are also
            provided by financial institutions pending the signing of regular term loan agreement, which
            may  be  delayed  due  to non-compliance of conditions  stipulated by  the institutions  while
            sanctioning the loan. The bridge loans are repaid/adjusted out of the term loans as and when
            disbursed by the concerned institutions. Bridge loans are normally secured by hypothecating
            movable assets, personal guarantees and demand promissory notes. Generally, the rate of interest
            on bridge finance is higher as compared with that on term loans.




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