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Secured Short Term Financing

Secured Short Term Financing

Author: James Howard

This lessons explains secured short term financing.

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Video Transcription

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Hello, and welcome to this tutorial on Secured Short Term Financing. Now, as always with these tutorials, please feel free to fast forward, pause, or rewind as many times as you need in order to get the most out of the time that you'll spend here. So let me ask you a question. What are some other options for short term financing that a business or we may have available to us if we don't want to do simply that unsecured short term financing?

Well, what we're going to be talking about in this tutorial is secured short term financing. We're also going to look at ways to secure loans and factoring. Now, secured short term financing happens when a business may not be able to get enough money or all the money that it needs through unsecured financing means. So if I can't get enough money or can't get any money, I may need to use secured financing instead.

I was going to use collateral in order to get this additional financing. And companies tend to have less than great credit ratings are going to need collateral. And almost any asset that a business has can be used or considered for collateral. But typically, inventories and accounts receivable are the most common assets that businesses will use to secure short term financing and put up as collateral.

Now, loans secured with inventory, generally this type of loan can be used by any business and is typically used with the products that it has on hand. And you won't typically see this used by a service company. So for instance, someone that provides a service like counseling or massage wouldn't have a whole lot of inventory on hand. So they wouldn't necessarily be securing short term loans with inventory.

Now, loans secured with receivables, on the other hand, can generally be used by any business, and may in fact be best for companies with longer sales and production processes because the receivables is more secure at this point. Startups, you typically won't see this because there's not a lot of receivables on the income statement.

Now, factoring. So what is factoring? Factoring is secured by receivables. And it bridges the gap just prior to sales. Now, a factor is a business that exclusively buys from other firms' accounts receivable for the purpose of making money. Now the firm that's selling its accounts receivable will receive less than face value, but it's going to get those funds immediately.

And then the factor is responsible for collecting that financing. Now, this is used typically by firms with a large number of credit customers to offset the risks on this type of loan. It'll be used by manufacturing or manufacturers to provide money needed to fund manufacturing processes and bridge gaps just prior to the sale of goods.

Now, as an example of financing, the manufacturing business may use a factoring account to temporarily get raw materials they need to build something, like the fabric or the labor, maybe the thread in order to build this really big order of t-shirts that they've already sold. It's in the receivables columns of their income statement, and it's going to be used to create the t-shirts for that particular order. So we already know the money's coming in.

Now, the factor is going to buy off of that accounts receivable. So we're going to give them a little less than face value, a little less than what they're asking for so the factor makes a little money. Now, I get, as the shirt manufacturer, all the money I need upfront to buy everything and fill that order and fulfill that order on time. So that when I collect my amount of money that I'm going to get for selling those shirts, I can then pay the factor back.

And this is a fairly low risk situation because all I have to do is sell something that I've already sold. And this is a type of loan that's secured by receivables. I know I'm going to be selling it. I know the money's coming in. It's just I need a certain amount of money right now. This will be an example of a loan that's secured by receivables.

Now, loans that are secured by inventory, on the other hand, let's go back to that shirt example. In that case, I would have a whole lot of t-shirts on hand, a whole lot of money sitting in my warehouse in the form of t-shirts. But in a case where I'm securing something by inventory, I'll take a loan based on the amount of inventory they have. And as I sell those shirts out, I then pay that secured short-term financing back.

So what is it we talked about today? Well, we looked at secured short term financing, things that are secured through both inventory and also through accounts receivable. We also looked at different ways to secure those loans. We know we're going to have to put up some type of collateral when we have a secured short term loan.

And it can be almost anything. Typically we're using inventory on hand or assets that we have on hand with the business, or we're borrowing against the accounts receivable that the business is bringing in. We know the money's coming. It's just a question of getting it at the right time to pay the loan back.

We also looked at factoring, or borrowing that money or securing that short term financing on something that's already been sold. I just need to get the materials together in order to sell or make that product, to sell it to collect the money to pay back the factor. Now, as always, I want to thank you for spending some time with me today, and you folks have a good day.