Short-term borrowings, also known as short-term debt or current liabilities, refer to funds that a company borrows for a period of one year or less. These borrowings are used to finance day-to-day operational expenses, working capital needs, or to address short-term cash flow gaps.
Nature of Short-Term Borrowings:
Short-term borrowings represent financial obligations that are expected to be settled within one year. They are typically used to address immediate financing needs.
Forms of Short-Term Borrowings:
Short-term borrowings can take various forms, including bank loans, lines of credit, commercial paper, trade credit, and other types of short-term credit arrangements.
Purpose and Use:
Companies utilize short-term borrowings to meet working capital requirements, finance inventory purchases, cover operating expenses, and manage cash flow fluctuations.
Interest rates on short-term borrowings are typically lower than those on long-term debt, but they can still vary depending on factors like the borrower’s creditworthiness and prevailing market conditions.
Short-term borrowings are expected to be repaid within one year. This makes them a suitable option for businesses facing temporary financial needs.
Risk and Liquidity:
While short-term borrowings can provide quick access to funds, they also come with the risk of higher interest rates and the need for timely repayment.
Sources of Short-Term Borrowings:
Short-term borrowings can be sourced from various entities, including commercial banks, financial institutions, trade creditors, and sometimes even from shareholders or related parties.
Impact on Financial Statements:
Short-term borrowings are classified as current liabilities on the balance sheet, reflecting the company’s obligation to repay the debt within the next year. They also affect the company’s interest expense on the income statement.
Renewal or Rollover:
In some cases, companies may choose to renew or roll over short-term borrowings if they are unable to repay them by the maturity date. This may involve negotiating new terms with the lender.
Prudent Use and Management:
It’s important for companies to use short-term borrowings judiciously and have a clear repayment plan in place to avoid financial strain and ensure they are used for productive purposes.
Relation to Working Capital Management:
Short-term borrowings are an integral part of a company’s working capital management strategy, helping to ensure that there is enough liquidity to cover short-term operational needs.
Short Term Borrowings Avenues
Banks offer short-term loans to businesses, providing them with a lump sum amount for a defined period, typically one year or less. These loans can be used for various purposes such as working capital, inventory financing, or covering operational expenses.
- Competitive interest rates.
- Formal application process.
- Requires collateral in some cases.
- Can be unsecured for established businesses with strong creditworthiness.
Lines of Credit:
A line of credit is a flexible borrowing arrangement where a financial institution extends a credit limit to a business. The business can draw funds up to the limit as needed, and interest is only charged on the amount borrowed.
- Interest is charged only on the amount borrowed.
- Provides flexibility in managing short-term cash flow needs.
- Usually requires collateral or a personal guarantee.
- Can be revolving (reusable) or non-revolving (one-time use).
Trade credit is a form of short-term financing where a supplier allows a business to purchase goods or services on credit terms, typically with payment due within a specified period (e.g., 30 days).
- Common in B2B transactions.
- No formal application process.
- Helps businesses manage cash flow by deferring payment for goods or services.
Commercial paper is a type of unsecured, short-term debt instrument issued by large corporations to raise funds. It is typically sold in the money markets to investors.
- Issued by well-established, creditworthy companies.
- Usually matures within 270 days.
- Provides a cost-effective way to raise short-term capital.
Invoice Financing or Factoring:
Invoice financing involves a business selling its accounts receivable (unpaid invoices) to a financial institution at a discount. The business receives immediate cash for the invoices.
- Provides quick access to cash flow tied up in unpaid invoices.
- Can be recourse (business retains risk) or non-recourse (financial institution assumes risk).
- Useful for businesses with slow-paying customers.
Supplier Financing Programs:
Some large corporations offer supplier financing programs to their vendors, allowing them to obtain financing at preferential rates based on their relationship with the buying company.
- Access to financing at favorable terms.
- Can enhance the financial stability of suppliers.
Microfinance Institutions and Online Lenders:
Microfinance institutions and online lenders provide short-term loans to small and micro-enterprises. These loans are often easier to access compared to traditional bank loans.
- Streamlined application processes.
- Quick approval and funding.
- May have higher interest rates compared to traditional bank loans.
Government Programs and Grants:
Some governments offer short-term financing programs or grants to support businesses, especially during economic challenges or for specific industries.
- May come with favorable terms or low-interest rates.
- Eligibility criteria and application processes vary by program.