Short-term Credits

The activity of the enterprise, even if it is making profit, goes often together with cash flow difficulties:

purchases always precede sales;
the suppliers demand quick payment, while the customers try to settle their debts the latest possible;
many regular payments (salaries, rents, repayments of loans) are uncoupled from the cycle of purchases and sales.

Short-term credits serve as "extra" cash flow for the enterprise until the receipts materialise into income of money.
The financial institutions:

short-term credits are more the responsibility of the commercial banks.

Here is however a short account of the main techniques utilised.

Cash credit

Principle:

Faculty for the enterprise to have a debit balance (negative) on its bank account.
The maximum overdraft is fixed by the credit establishment depending on the situation of the enterprise.
The agreement between the bank and its client provides generally for a deadline for repayment of the negative balance.

Advantages:

It is a very flexible tool. Once granted the cash credit can be used and repaid according to the needs of the enterprise.
The interests are calculated on the actual utilisation of the credit line.

Utilisation:

Financing of the short-term cash-flow needs: the enterprise utilises a bank overdraft that will be filled shortly afterwards by money coming in.

Currency:

The currency of the concerned account.

Term:

The credit opening is entered into for an undetermined term. However when the enterprise makes use of its credit line, the contract provides generally for a deadline for returning to a positive balance.

Cost:

Cash credit is a very expensive formula, as the interest rate is very high (it is not seldom that it turns around 15% in Europe). It is thus important to use it only for financing cash-flow deficits caused by the gaps between payments from customers and payments to suppliers.

Conditions of grant:

The maximum will be fixed depending on the needs of the enterprise, on the basis of an analysis of its cash flow.
The interest rate will depend on the size of the authorised overdraft and of the "risk profile" of the enterprise.
The credit establishment may demand guarantees.

Terms of repayment:

Provided the obligation to come back regularly to a credit balance is satisfied, the enterprise borrows and reimburses at its pace.
In some cases the contract may provide for gradual reduction of the authorised maximum.

Straight loan

Principle:

"Classical" short-term loan: borrowed amount, term and interest rate are fixed at the time of signature of the contract.

Advantages:

The fixed expiry date gives the bank more certainty, which allows the enterprise to get a lower interest rate than for a credit opening.

Utilisation:

Financing of short-term cash flow needs. The use of the mechanism of the straight loans demands rigorous management of the cash flow. As a matter of fact only a good knowledge of the spreading of the receipts and expenses allows the enterprise to determine the maturity date of the requested advances.

Term:

It is a short-term credit that can go from a few months to one year as a maximum. The term is fixed at the time of the signature of the contract and depends on the maturity dates provided in the cash-flow plan.

Cost:

The interest rate is high, but lower than that of the cash credit.

Discount Credit

Principle:

The discount credit consists for an enterprise in drawing a draft (asking a certificate of indebtedness from its customer) on its customers and discounting it then with its bank, that is the bank "buys" the trade debt from its customer at a slightly lower price than its value. At the maturity date, the customer of the enterprise pays the amount of its debt directly to the bank.

The difference between the total of the debt and the amount paid by the bank is called "agio". It includes a commission, as well as an interest calculated on the duration between the time of the discount and the maturity date of the debt.

The discounted debt will be paid directly to the banker by the final debtor (the debtor of the trade debt).

The debt is represented by a draft (bill of exchange or promissory note).

Advantages:

The enterprise can mobilise immediately funds that would otherwise only be available in the future.

The loan is guaranteed by a future income.

Utilisation:

Financing of short-term cash-flow needs.

Cost:

As this is an advance on a future payment, the discount credit will cost less than cash-flow facilities or a straight loan.

Conditions of grant:

The operation presents a risk for the bank: that the final debtor will not pay his debt at the maturity date. It will hence condition the acceptance of the debt to a check of the debtor's solvency.

Discount has hence an important administrative cost and will only be justified for high amounts.

The discount credit will generally be granted conditionally: if the debtor refuses to pay his debt, the bank will claim repayment thereof from its customer.

Terms of repayment:

The final debtor performs the repayment at the expiry date.

Two types of discount:

The assignor-discount or customer discount:

It is the most usual form of discount. The enterprise supplies goods or a service to the customer and grants it a time limit for payment. It draws a draft on that customer.

It then presents the draft for discounting to its banker. If the banker accepts, the debt becomes its property. It pays to the enterprise the amount of the debt reduced by the agio.

At the maturity date, the bank claims payment from the customer who will comply.

The supplier discount:

It is a more unusual form of discount that allows the enterprise to have a time limit for payment while paying immediately its supplier.

The enterprise buys goods or services from its supplier and accepts to sign a draft.

The supplier presents immediately the draft to the bank of the enterprise. The bank pays the amount of the draft to the supplier and charges the agio on the account of the enterprise.

At the maturity date the bank charges the account of the enterprise with the total amount of the invoice.

Factoring

Principle:

Factoring is initially a mechanism by which a specialised enterprise (the factor) takes care on its customer's behalf of the management of the collection of invoices. The customer is so relieved of the tasks of checking payments, managing reminders and collecting unpaid invoices. In return it pays the factor a commission on all the invoices entrusted to it.

Most factoring companies propose also to their customers a system of guarantee: the amount of each invoice (reduced by the commission) will be paid at the agreed maturity date, whether the company to which the invoice is addressed has or not settled its debt, on condition for the factor to collect unpaid debts.

Eventually some of them propose to their customer a system of discount of invoices similar to the discount credit.

Advantages:

The enterprise is fully discharged of the tasks associated to the follow-up of invoicing.

Within the framework of the system of guarantee, it is the factor that will take care of the collection procedure.

Invoice discounting allows the customer to finance its short-term cash-flow needs without resorting to advances or cash credit.

Cost:

The cost depends on the chosen factoring formula. Generally it includes a fixed part that concerns the simple management of the collection and a percentage of the invoiced amounts if the enterprise calls on the guarantee system and discounting of invoices.