The financing is considered for the short term when the business is bound to make repayment within the next 12 months. This type of financing is classified in the short-term liability section of balance sheet. The interest paid on the short terms financing is taken to the profit and loss statement as finance expense.

Let’s discuss frequently used sources of business finance.

Bank Overdraft

Bank overdraft is considered a quick and easy source of short-term financing. The best part of this financing strategy is immediate availability, probably without extended procedural formalities. By looking at the transaction pattern or some collateral, the bank may provide this financing facility.

The interest is charged on the overdrawn balance and debited when you make a deposit. So, it’s easy and does not involve extended procedural compliance.

Short term loan

The business may opt to enter a financing facility with some bank, financial institutions, directors or any other related parties. It may be secured or unsecured financing, depending on the agreement between parties in the transactions.

It’s a traditional business loan that may be secured or unsecured. However, it has to be repaid within a year.

 Receivable factoring

Receivable financing means the business sells its receivable balance to some third party. In fact, they sell their right to receive the cash against receivable in the future.

By factoring in the receivable, the business receives funds today instead of funds to be received in the future. However, there is a difference in the amount when factoring in the receivables. For instance, if the business has $1,000 as receivable and decides to opt for factoring. The factoring company will buy this balance below $1,000. For instance, the amount may be 900, 800 or even less, depending on the agreement between the business and the factoring company.

Merchant cash advance

Merchant cash advance means the business receives advance funds against future sales/revenue. It’s usually available for businesses that use banking channels to generate sales. In place of the interest rate, the factor rate is used for pricing purposes. For instance, factor rate 1.3 implies that the business will be required to pay back 30% more cash. 

The best part of this financing is immediate cash availability, and the repayment is to be made using future revenue. However, it’s a little bit more expensive than traditional sources of finance.

Invoice discounting

Invoice discounting means the business sells an unpaid invoice to the financing company. It helps the business to immediately access the funds. However, funds are received at a discounted rate. For instance, the unpaid invoice amounting to $1,000 may be discounted to $800.

The current portion of long-term loan

 It’s a portion of the long-term loan payable in the next 12 months. The business is required to classify this balance in the current liability section and ensure payment for the same is arranged on a timely basis. Non-payment/late payment might lead to impaired loan convention and financial repercussions.

Is short-term financing more expensive than long-term financing?

No, short-term financing is less expensive than long-term financing. This is because the risk in short-term financing is lower than that of long-term financing. In other words, the lender is expected to receive their funds in less time when providing a loan for a shorter period.

Hence, the interest rate on short-term financing is relatively low.

Conclusion

Short-term financing is when the business raises funds with the intention to make repayment within 12 months. This liability is shown in the current liability section of the balance sheet.

There are different types of short-term financing: overdrafts, short-term loans, receivable factoring, merchant cash advance, invoice discounting, and the current portion of long-term financing etc.

Short-term financing is comparatively cheaper than long-term financing. It’s because the risk involved in long-term financing is relatively higher than in short-term financing.