Some sources of funds, which are created during the course of normal business activity have zero cost and are termed as spontaneous sources.
Some sources of funds, which are
created during the course of normal business activity have zero cost and are
termed as spontaneous sources. For example suppliers supply goods; employees
provide services where the payment are made at a latter stage. To an extent,
the payment is delayed and the funds are made available to the
firm. These are called trade liabilities or current liabilities. The two
important spontaneous sources of short-term finance are (a) Trade credit and
(b) Outstanding expenses / accrued expenses. These are explained in detail
The credit extended in connection with the goods purchased for resale by a retailer or a wholesaler for materials used by manufacturers in producing its products is called the trade credit.
Trade credit is a form of short-term financing common is almost all types of business firm. As a matter of fact, it is the largest source of short-term funds. The amount of such financing depends on the volume of purchase and the payment timings. Small and new firms are usually more dependent on the trade credit, as they find it difficult to obtain funds from other sources. This trade credit may be extended to the customers in the form of
1. An opening account credit and
2. Acceptance credit management / bills payable.
Trade credit is mostly an informal arrangement, and is granted on an open account basis. Open account is usually extended only after the seller conducts a fairly extensive investigation of the buyer’s standard and reputation. In the case of open account credit arrangement the buyer does not sign any formal debt instrument as an evidence of the amount due by him to the seller. The only evidence is the copy of the invoice that goods have been delivered. Open account trade credit appears as Sundry creditors
on the buyer’s balance sheet in the liability side.
(ii) Acceptance credit / Bills payable Trade credit may also take the
form of Bills payable. In such a case the buyer accepts a bill of exchange or
gives a promissory note for the amount due by him to the seller. This bill has
specified future date, and is usually used when the supplier is less sure about
buyers’ willingness and ability to pay or when the suppliers’ wants cash by
discounting the bill from a bank. Thus, it is an arrangement by which the
indebtedness of the buyer is recognized formally. This appears in the buyer’s
balance sheet as accounts payable or bills payable.
of Trade Credit
availability: Unlike other sources of finance trade credit as a source of finance relatively easy to
obtain. The easy availability is very important in the case of small and medium
firms where they cannot raise funds in the capital market.
The trade credit increases or decreases depending upon the growth of the firm. Moreover it
need not pledge securities or adhere to strict payment schedule.
Trade credit is an informal spontaneous source of finance. It does not require signing in the negotiable instruments
to obtain the credit.
cost: The trade credit is usually very high when compared to cash sales. The seller while fixing
the selling price will consider all explicit and implicit costs.
Trade credit facility may induce the buyer to buy a large quantity as a result it may occur in over trade.
Another spontaneous source of short-term financing is
the accrued expenses as the outstanding expense liabilities. Accrued expenses
refer to services received by the firm but the payment for which has not been
made. The accrued expenses represent an interest free source of finance.
There is no explicit and implicit cost included in
the accrued expenses. The most common accrued expenses are salary, wages and
taxes. In these cases the amount may be due but the payments are not paid
immediately. For example a firm may have a policy of paying salary and wages on
a monthly basis. Similarly, the sales commission or target incentives, sales
tax etc. are always payable with a time lag. The interest on debentures and
borrowings is also payable periodically and thereby provide funds to the firms
for the intervening period between two interest rates.
Interest free cost The accrued expenses are interest
free sources of financing. It is consistent with the general philosophy of
paying the creditors as late as possible as long as the firm does not damage
its credit rating.
Demerits Postponement of salary and wages
beyond normal level will affect the morale of the employees, resulting in
reduced efficiency and higher labour turnover.
Tags : Financial Management - WORKING CAPITAL MANAGEMENT
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