Short-term loans are borrowed funds used to meet obligations for just a few days or up to a year. Anything longer is not short term. With a short-term loan, you receive the cash from your lender more quickly, but it also needs to be repaid in a shorter time frame.
One of the most common ways for start-ups to get funding is the asking of families and friends. A young and energetic entrepreneur may have a great idea for a start-up but doesn't have the money in his personal savings. Friends and family may be older and have some money set aside. Parents or other family members should not risk all of their retirement savings on the start-up but they may be willing to risk a small amount to help the entrepreneur out.
Sometimes friends similar in age are willing to work for little or no wages until the cash flow turns positive. The term sweat equity is often used for this type of contribution. The owner rewards this type of loyalty with a small percentage of ownership of the organization in lieu of cash. A variation of this is barter or trade. This is the method where a service such as consulting or management advice is provided in return for the resources needed for the start-up.
After friends and family, there has been an increase in person-to-person lending, also called peer-to-peer lending or P2P lending. This type of lending occurs directly between individuals or peers without the intermediation of a traditional financial institution. For the most part, peer-to-peer lending is a for-profit activity that distinguishes it from charities, philanthropy, or crowdfunding.
Peer-to-peer lending saw huge growth during the economic crisis of 2007 through 2010. Peer lenders were willing to provide credit at a time when banks were not willing to lend. In P2P lending, lenders could charge below-market rates to help the borrower and lessen the risk.
One advantage to the borrower is that rates may be better than the rates that traditional banks can offer. The advantage to a lender is they would get a higher return than they would if they just had the money in a low-yield savings account.
Commercial banks offer loans to businesses and can be secured or unsecured.
When the business is a going concern, the most common type of short-term financing is the use of trade credit. Trade credit is a valuable source of alternative funds for personal and business loans. This is the money owed by a business to its suppliers when inventory is received and is recorded on the balance sheet as accounts payable until it is paid. Most often, a supplier will send an order to a business, issue a bill, and collect the payment later. This is an important part of the cash conversion cycle because the business has the inventory but they have not paid cash for it yet.
Sometimes the supplier will offer a discount if the bill is paid early. An example of these terms may be "2/10 Net 30." This means that the business can take a 2% discount if it pays within 10 days; otherwise, the balance due must be paid in 30 days. While the discount might seem attractive, the business must weigh that against shortening its cash conversion cycle by 20 days, as in this case.
It is also important not to abuse any trade credit extended. The business could run the risk of not having that credit available due to slow payment.
A less widely used method of short-term financing is factoring. Here, a business sells its accounts receivable to a third party, called a factor, at a discount. This allows the business to convert a substantial part of its accounts receivable to cash. Therefore, it could pay its suppliers and other debtors more quickly.
This transaction can be negotiated with or without recourse.
Source: THIS CONTENT HAS BEEN ADAPTED FROM LUMEN LEARNING'S “Short-Term Financing” TUTORIAL.