short term business finance

short term business finance

The Importance of Short-Term Business Finance: Strategies for Success

1. Introduction to Short-Term Business Finance

Credit is the basis of trade and the majority of the transactions involved do not require immediate settlement. In the initial stages of the growth of trade and commerce, these requirements were met simply, in cash, with or without the help of independent goldsmiths and moneylenders, who acted as bankers. Firms accumulated short-term debtors as goods, to be converted into cash. As the business cycle developed, the increasing volume of debtors was often not matched by an appropriate increase in short-term finance. The problem of seasonal peaks, depleted by the assets of businesses and monetary systems fully supporting trade and commercial expansion amongst increasing population, intensified in a self-reinforcing manner, and over time affected not only particular firms but also those banks that held the savings of the general public.

Short-term finance has always been vital to the development of business cycles. Whether a firm is involved in retailing, manufacturing, farming, trading, or any other commercial activity, all are involved in a mixture of long and short-term finance decisions. Exactly what short-term business finance refers to can be difficult to identify. The term business finance can, traditionally, be divided into long-term finance, which deals with investments in fixed assets such as the replacement of plant and machinery and provision for long-term future needs, and short-term finance, which is associated with working capital such as the stock of raw materials and goods, spare parts and maintenance services, and a firm’s debtors account. These are those sums owed to it by trade debtors.

2. Key Components of Short-Term Business Finance

The purpose of long-term capital for the business is to finance fixed assets and provide a long-term capital cushion for that venture. The purpose of short-term business finance is different. It refers to the kind of funding that a company’s operations and needs. In particular, these are its liquid assets. Short-term borrowing is one way of solving business problems. A business will use its liquid funds – which are its current asset side – in order to meet its requirements the day-to-day costs of providing its goods or services. The short-term finance for a business, such as overdrafts, or even merchant banking is another way of providing the necessary funds that will service those day-to-day running costs and requirements. Such financial help is needed to finance the money owed to suppliers and wages, for example.

The first step to identifying your requirements in this area is to examine the factors involved in the financial planning process. Different businesses will have varied interpretations of what short-term business finance actually entails. Working capital requirements do not just apply to businesses that operate in what you might traditionally think of as a financial or liquid way. They might apply to non-financial businesses as well, those businesses that make things, rather than sell financial products such as banks, or insurance solutions, or funds. These businesses will also require correct management of their working capital requirements. These aren’t just long-term borrowings, for example, which are usually loans taken out over several years, such as through a debenture. A business may choose to pay this in either one lump sum at the end, or in monthly instalments.

3. Strategies for Effective Cash Flow Management

These strategies are provided to give you a general plan for cash flow management. Our purpose is to stimulate your thinking and to assist you in customizing a plan that will meet the particular demands of your company. Every idea we present may not work in your situation, and you may think of other strategies not mentioned in our discussion. As you become more aware of the true value of cash, you will develop working capital practices that keep pace with the dynamism of a modern business environment. Since the speed of technological advancement in the modern business world keeps accelerating, the effective management of working capital becomes more crucial, but it also has even greater potential for fundamental innovation and improvement.

Certain skills and techniques can help you control cash flow more effectively. You can adopt various strategies and develop a plan that is custom-built for your company. Although many of these strategies are basic, they work and are often applicable to other companies and to other time periods. There are really only two ways to improve your company’s cash position: (1) Increase cash receipts; or (2) Decrease cash distribution. We’ll discuss several variations of these two methods. While reviewing the material, keep in mind that our goal is to concentrate on overall cash flow management (the big picture of a company’s use of cash). Our goal is not to examine working capital or other ways to acquire funds in any detail.

4. Utilizing Short-Term Financing Options

Commercial paper is an unsecured promissory note that a large company issues to raise money. It represents short-term debt with a maturity of less than 270 days. Financially strong companies often use commercial paper to fund significant cash use (e.g., large-scale capital projects) or to pay off funds (e.g., retire long-term debt) from bank loans. Accruals offer businesses financial flexibility; using the company’s operating cycle or profit margins to obtain resources from suppliers. Business accountants use the working capital accounts of the company to determine how many accruals to apply. The effectiveness of using accruals depends on their timeliness. Good sources of short-term funds typically have flexibility that allows use in the near term. Accruals fulfill this criterion, as many suppliers provide the business with terms to remit the money after a service or product is supplied. Additionally, companies may receive extended terms from other vendors in the forms of accrued taxes, wages, and benefits.

Banks provide many short-term loans (credit lines) to businesses. The two most common credit lines are lines of credit and demand loans. A line of credit often comes with a 12-month renewable loan agreement. Under its terms, a firm can borrow, repay, and reborrow during the borrowing period. Demand loans are short-term loans made without any written agreement for a specific term. The banks charge businesses a higher interest rate on demand loans than on credit lines because of the greater potential risk associated with demand loans. Frequently, a firm needs a credit line greater than that approved by the bank. A practice called short-term borrowing occurs when firms with credit lines smaller than desired use a tactic known as loan stacking. Successful completion of this tactic is ensured by the company’s not informing the banks about recent borrowing agreements.

5. Case Studies and Best Practices

Alfie’s Forever Home is a relatively new pet store and training center based in the heart of Leeds. It already achieved considerable success, with sales of €240,000 in its first year of trading. The company has also won a Mini-Pet Entrepreneur competition held by the local council. This quickly led to a much larger store to serve the robust demands of the growing customer base. In the pet supply industry, seasonal peaks and troughs in business are a fact of life, as one of the suppliers said – “It’s typically quiet in the summer months until pets go and on their summer to weeks to get mucky and then it is super-busy for about a month afterwards”. The staff also mentioned that buying stock well can result in great prices, but their limited knowledge meant that they were squandering some of the lovely unique temporary deals that they had. Small accounting glitches can amount to significant lost revenue over the year – they wanted a stress-free way to locate their products with great deals, in which the price changes with every delivery.

Alfie’s Forever Home, Leeds

Situated in the historic town of Chesterfield, CSR Ice Cream has enjoyed great success since opening its first outlet in 2013. Today, the enterprise serves over 2,000 people a week across four outlets in the towns of Chesterfield, Matlock, Bakewell, and Derby. Last year, the company was named Chesterfield’s Retailer of the Year and also made the top three in the Derbyshire Food and Drink Awards. Despite its plans, CSR encountered negative cash flow in the winter months when most people stop eating ice cream! It needed some working capital to see it through to the summer but also to pay for additional machinery as part of a major investment in sales expansion. The company had already made deductions as part of its business plan, but the banks’ approval process would take too long. The company could not afford to wait and sought a solution within short-term finance. Confident in the company’s ability to execute and with the self-employed couple standing behind the agreement, we were prepared to help. Upon drawing the first loan, CSR had enough funding to ease its winter cash flow needs and invest in the new equipment, allowing them to drive existing year-on-year increases with less risk.

CSR Ice Cream, Chesterfield

The best way to illustrate the advantages of short-term business lending is to refer to case studies. In this section, we cover three fictional examples, and we conclude with best practices based on our own experience of short-term lending and conversations with those that have used this form of funding.