Finance is what allows businesses to exist. Adequate finance is required to meet the various commitments arising out of business transactions. The financial requirements of business can be broadly classified into two categories: short-term sources and long-term sources.
Short-term finance is required to meet the working capital requirements of a business firm. These are the funds required for a one-year period. The sources of short-term finance are trade credit, bank borrowings, factoring of receivables, commercial paper, and accrued expenses and deferred income. Trade credit refers to the type of credit provided to customers by suppliers of goods in the normal course of business transactions. Trade credit is easily available and is dependent on the personal relationship between the supplier and the buyer. It also offers better access to small and newly established businesses by selling the goods on a credit basis.
Banks are an important institutional source of financing for working capital needs. Banks consider various aspects, such as the production and marketing plans of the customer, while determining the credit requirements. The amount so determined by the bank is known as the credit limit. Bankers are required to fix separate credit limits for various types of credit facilities to be extended to various types of borrowers. Before granting finance, the banker maintains margins. This is based on the principle of conservatism and was decided to ensure the safety of funds.
Banks extend the following types of financial facilities to customers: Overdraft, cash credit, purchase or discounting of bills, and demand loans Overdraft is a temporary arrangement whereby the customer is allowed to draw over and above the balance standing to the credit of the customer. Under the cash credit facility, a borrower is permitted to withdraw funds from the bank up to the sanctioned credit limit. Demand loans are called the “ad hoc” or “temporary” financial accommodations granted to customers to meet unforeseen contingencies. The borrower has to pay a higher rate of interest on these types of advances.
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