Q.Explain trade credit and bank credit as sources of short-term finance for business enterprises.

Short-term finance is needed to meet a firm's day-to-day working-capital needs, and trade credit and bank credit are two of its most common sources.

Trade credit

• Meaning: Credit extended by one trader to another for the purchase of goods and services — it lets a firm buy supplies without paying immediately. In the buyer's books it appears as "sundry creditors" or "accounts payable." It is a very common source of short-term finance.
• Who gets it / how much: Granted to customers of reasonable financial standing and goodwill; the volume and period depend on the buyer's reputation, the seller's financial position, the volume of purchases, the buyer's past payment record, and the degree of competition.
• Merits: A convenient and continuous source; readily available when the seller knows the buyer's creditworthiness; helps promote sales; useful for financing a planned rise in inventory ahead of expected demand; creates no charge on assets.
• Limitations: Can tempt a firm into overtrading (raising its risk); only a limited amount can be generated; and it is generally a more expensive source than most others.

Bank credit (loans from commercial banks)

• Meaning: Commercial banks provide funds for different purposes and periods through cash credit, overdrafts, term loans, purchase/discounting of bills, and letters of credit. The interest rate depends on the firm's characteristics and market rates; repayment is in a lump sum or instalments.
• Nature: Bank credit is not a permanent source — loans are generally for medium to short periods, and the bank requires the borrower to give security or create a charge on assets.
• Merits: Timely assistance (funds as and when needed); secrecy (information kept confidential); fewer formalities (no prospectus or underwriting); and flexibility (amount can be increased as needs grow and repaid in advance).
• Limitations: Funds are usually for short periods and their renewal is uncertain and difficult; banks make a detailed investigation and may demand security and personal sureties; and they may impose difficult terms (such as restrictions on the sale of mortgaged goods) that hamper normal working.