Source: Image of long arrow, LCD monitor, images by Video Scribe, License held by Jeff Carroll; Image of contract, Public Domain, http://bit.ly/1o4lUug.
Hi, I'm Jeff. And in this lesson, we'll learn about some of the options businesses have for short-term financing, such as trade credit or promissory notes. So let's get started.
If you recall, short-term financing is a loan that must be repaid within a year. And it is easier to get than long-term financing. Organizations use short-term financing for a variety of business needs, such as speculative production. And it does not necessarily indicate a business is having any financial issues.
Since short-term financing does not normally require collateral, it is often referred to as unsecured financing. Unsecured financing is a loan of funds based solely on an agreement between two parties that one will pay the other. No physical items are offered as collateral on the loan.
This type of financing is easier for a business to obtain, because the short repayment period has been shown to be less risky for the lender. The amount borrowed is normally smaller than long-term loans. And typically, there is a working relationship between the lender and the lendee.
When a lender, such as a bank, provides an unsecured short-term loan to a credit worthy business, they usually charge prime interest rate, which is the interest rate banks charge to their best commercial customers. For less credit worthy customers, the bank might add additional percentages onto the prime interest rate. And for consumers, banks usually charge an annual percentage rate for a whole year, which is similar, but generally higher than the prime interest rate.
Now, let's discuss the types of short-term loans. One type is a trade credit, which is credit which suppliers extend to their customers for a specific period of time, usually 30, 60, or 90 days. This is often used with retailers so they can delay their payments until after their merchandise has been sold. It is also often used by startups in order to obtain initial inventory.
With trade credit, a seller will often offer a buyer a trade discount if they pay immediately upon delivery or the full charge if the buyer waits until a later date, such as the 30 or 60 days. Credit worthy businesses can often take advantage of this trade discount, which also helps show a healthy accounts payable balance. If no trade discount is offered, then a buyer might as well wait until the full 60 or 90 day repayment period, since that is essentially an interest free loan. And it will help with the buyer's cash flow.
For example, if a buyer wants to purchase 100 LED monitors and the seller offers a 60 day trade credit without a trade discount for paying early, the buyer might always wait the full 60 days to make repayment. So they can sell as many of the 100 monitors as possible to their own customers without any real cost to the business. Now let's go on.
Another type of short-term financing is a promissory note, which an agreement to pay a specific amount of money at a certain time or under certain circumstances. Interest is normally charged on these. The repayment period for notes is usually between 60 to 180 days.
Note that a promissory note is a legal document and can be used in court. They can also be sold and negotiated since they are a contract that represents a certain value of money. For example, a company can decide to sell a promissory note to a bank before the maturity date. The bank would take over the risk on the note. And the company would get immediate money.
For this service, the bank would pay less for the note than its full value. So the bank would make money when the note matures. And the original lendee pays the bank for full amount. OK, good job.
In this lesson, we learned about the advantages of short-term financing. We talked about why it is sometimes called unsecured financing. And we discussed two types of short-term financing, trade credit, and promissory notes Thanks for your time, and have a great day.