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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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