Borrowing and Investing

Sources of short term funding

Overdrafts: An overdraft is a facility granted by a bank which a business may or may not use. An overdraft is particularly suitable for financing day to day fluctuating requirements and is technically repayable on demand.

Short-term loans: The advantage compared with an overdraft is that the bank cannot request repayment until the end of the loan period. A disadvantage is that interest is payable for the entire duration of the loan, whereas the overdraft incurs interest only when the balance is overdrawn.

Trade payables: Taking credit from suppliers in the normal course of business is, on the face of it, a free source of finance. However it does have its costs in terms of potential early payment discounts forgone. Also if the credit period becomes excessive then supplier goodwill might be lost and the company's credit rating might be affected adversely.

Factoring: Factors are organisations that advance cash against the security of the company's receivables. The factor will advance up to 80% of the value of the debts, in return for a commission charge and interest. The factor will pay the remainder of the money to the company when the customers have settled their debts. The main advantage to the company is the reduction in the cost of administering the receivables ledger and credit control activities.

Sources of export finance

Bills of exchange: These allow the exporter to obtain immediate finance instead of having to wait until the end of the credit period, when the bill matures.

Forfaiting: This is where a bank purchases from a company a number of sales invoices or promissory notes, usually obtaining a guarantee that the invoices or notes will be paid.

Documentary credits: The buyer's bank issues a letter of credit in favour of the exporter. The bank thereby guarantees payment to the exporter, which is particularly valuable where the risk of non-payment is high.

Exporters can also use an export factoring service, which is similar to the factoring of domestic trade debts discussed earlier.

Investment opportunities for short-term surpluses

The choice of investment requires a consideration of a number of factors.

Profitability: The optimum return must be earned on the funds invested.

Liquidity and appropriate maturity: It is important not to tie up short-term surplus funds so that they cannot be accessed when they are needed.

Safety: Any surplus must be kept secure and some investments are riskier than others.

Diversification: Risk can be reduced by investing in a range of different types of separate investments.

What opportunities are there to invest a short term surplus?

Interest bearing bank accounts: A range of accounts are available offering different facilities for earning interest on cash deposits.

Short term treasury bills: This is a government debt which does not pay interest, but which is issued at a price that is less than its value on maturity.

Marketable securities and negotiable instruments: These include gilts, bonds and certificates of deposit. They all earn interest and can be bought and sold.

Risk

Whatever the choice of investment, the risk must be assessed. Risk can be considered in terms of its effect on income, capital or both.