Short-term credit management

A short-term loan is a type of loan that is obtained to support a temporary personal or business capital need. As it is a type of credit, it involves repaying the principal amount with interest by a given due date, which is usually within a year from getting the loan.

Short-term debt, also called current liabilities, is a firm’s financial obligations that are expected to be paid off within a year. It is listed under the current liabilities portion of the total liabilities section of a company’s balance sheet.

Objectives

• To be able to take the necessary steps to establish credit and develop a credit history.
• To evaluate reasons for and against using credit and decide whether credit is appropriate.
• To identify what is meant by sales credit and how it is used.
• To identify the important characteristics of installment loans.
• To understand how to use credit cards properly and to know your legal rights as a borrower against credit mistakes.
• To compare the various sources of credit and to learn what to do if you experience credit problems.

Types:

Invoice financing

This type of loan is done by using a business’ accounts receivables invoices that are, as yet, unpaid by customers. The lender loans the money and charges interest based on the number of weeks that invoices remain outstanding. When an invoice gets paid, the lender will interrupt the payment of the invoice and take the interest charged on the loan before returning to the borrower what is due to the business.

Payday loans

Payday loans are emergency short term loans that are relatively easy to obtain. Even high street lenders offer them. The drawback is that the entire loan amount, plus interest, must be paid in one lump sum when the borrower’s payday arrives.

Repayments are typically done by the lender taking out the amount from the borrower’s bank account, using the continuous payment authority. Payday loans typically carry very high interest rates.

Merchant cash advances

This type of short term loan is actually a cash advance but one that still operates like a loan. The lender loans the amount needed by the borrower. The borrower makes the loan payments by allowing the lender to access the borrower’s credit facility. Each time a purchase by a customer of the borrower is made, a certain percentage of the proceeds is taken by the lender until the loan is repaid.

Online or Installment loans

It is also relatively easy to get a short term loan where everything is done online from application to approval. Within minutes from getting the loan approval, the money is wired to the borrower’s bank account.

Lines of credit

A line of credit is much like using a business credit card. A credit limit is set and the business is able to tap into the line of credit as needed. It makes monthly installment payments against whatever amount has been borrowed.

Therefore, monthly payments due vary in accordance with how much of the line of credit has been accessed. One advantage of lines of credit over business credit cards is that the former typically charge a lower Annual Percentage Rate (APR).

There are usually two types of debt, or liabilities, that a company accrues financing and operating. The former is the result of actions undertaken to raise funding to grow the business, while the latter is the byproduct of obligations arising from normal business operations.

Financing debt is normally considered to be long-term debt in that it is has a maturity date longer than 12 months and is usually listed after the current liabilities portion in the total liabilities section of the balance sheet.

Operating debt arises from the primary activities that are required to run a business, such as accounts payable, and is expected to be resolved within 12 months, or within the current operating cycle, of its accrual. This is known as short-term debt and is usually made up of short-term bank loans taken out, or commercial paper issued, by a company,

The value of the short-term debt account is very important when determining a company’s performance. Simply put, the higher the debt to equity ratio, the greater the concern about company liquidity. If the account is larger than the company’s cash and cash equivalents, this suggests that the company may be in poor financial health and does not have enough cash to pay off its impending obligations.

The most common measure of short-term liquidity is the quick ratio which is integral in determining a company’s credit rating that ultimately affects that company’s ability to procure financing.

Quick ratio = (current assets – inventory) / current liabilities

Advantages of Short Term Loans

There are many advantages for the borrower in taking out a loan for only a brief period of time, including the following:

Quick funding time

These loans are considered less risky compared to long term loans because of a shorter maturity date. The borrower’s ability to repay a loan is less likely to change significantly over a short frame of time. Thus, the time it takes for a lender underwriting to process the loan is shorter. Thus, the borrower can obtain the needed funds more quickly.

Shorter time for incurring interest

As short-term loans need to be paid off within about a year, there are lower total interest payments. Compared to long term loans, the amount of interest paid is significantly less.

Easier to acquire

Short term loans are the lifesavers of smaller businesses or individuals who suffer from less than stellar credit scores. The requirements for such loans are generally easier to meet, in part because such loans are usually for relatively small amounts, as compared to the amount of money usually borrowed on a long term basis.