Short-Term and Modern Sources of Finance — Trade Credit, Commercial Paper, Lease Financing, Factoring and Venture Capital

Alongside the traditional long- and medium-term sources, businesses regularly use a set of short-term and more specialised instruments to meet immediate working-capital needs or to access funds without taking on a traditional loan.

Trade credit is the credit that a supplier extends to a business when it purchases goods or raw materials, allowing the buyer to pay for the goods after a certain period rather than at the time of purchase. It is one of the most widely used short-term sources of finance, especially for businesses that maintain steady, repeat purchases from the same suppliers, because it is usually extended without any formal documentation or explicit interest charge, based purely on the buyer's creditworthiness and payment record. Because no interest is normally charged as long as payment is made within the agreed period, trade credit is often regarded as a relatively low-cost or even interest-free source of short-term finance, though a business that regularly delays payment beyond the agreed period risks straining supplier relationships and may eventually be denied further credit.

Commercial paper is a short-term, unsecured promissory note issued in the money market by large, financially strong and creditworthy companies to raise funds for a brief period, typically to meet working-capital needs. Because it is unsecured, only companies with a strong credit standing and reputation are able to issue commercial paper at a reasonable cost, and it is usually sold to other companies, banks, and financial institutions with surplus funds looking for a short-term investment. Commercial paper is generally a cheaper source of short-term funds than a bank loan for a company with a very good credit rating, but it is available only to large, well-established firms and not to small or medium enterprises.

Lease financing allows a business to use an asset, such as machinery or equipment, without purchasing it outright and without having to pay the full cost upfront. Under a lease agreement, the owner of the asset (the lessor) allows another party (the lessee) to use the asset for an agreed period in exchange for periodic lease rental payments. At the end of the lease, depending on the type of agreement, the asset may be returned to the lessor or, in some cases, transferred to the lessee. Lease financing lets a business acquire the use of an expensive asset while conserving cash that would otherwise have gone into an outright purchase, though over the full life of the asset the total lease rentals paid may work out to be higher than the cost of buying it outright.

Factoring is an arrangement in which a business sells its trade receivables, that is, the amounts owed to it by its own customers (debtors), to a specialised financial institution known as a factor, in exchange for immediate cash, usually at a discount to the face value of those receivables. This allows the business to convert money that is tied up in unpaid customer bills into ready cash straight away, improving its cash flow, instead of waiting for the normal credit period to expire before its customers pay. The factor takes over the task, and often the risk, of collecting the amount from the debtors. Factoring is particularly useful for a business that sells on credit to many customers and needs cash quickly to keep its own operations running, though the discount charged by the factor is the cost of obtaining that immediate liquidity. …