Short-term finance: covering a timing gap, not buying equipment

1. Short-term finance covers a timing gap of weeks or months, such as the negative closing balance a cash-flow forecast shows for February, when money leaves the business before the money coming in arrives.
2. The gap closes by itself once customers pay or trade picks up, so the borrowing is cleared inside the year rather than sitting on the books.
3. It is the wrong tool for an oven, a van or a second shop, because those are long-term needs met by the long-term sources in 1.3.4b, and Edexcel names exactly two short-term sources: an overdraft and trade credit.

Overdraft: borrowing on your own account, only on the days you dip into it

1. The bank agrees a limit, say £3,000, and charges interest only on the amount actually overdrawn and only for the days it is overdrawn, which gives an overdraft two advantages over a loan.
   1. Flexibility: dipping £400 below zero for six days costs interest on £400 for six days rather than on a whole borrowed sum for a whole year, so the business borrows only what it needs on the day.
   2. Speed: an overdraft is arranged with the bank in days and then sits unused until it is needed, which suits a shortfall that appears at short notice.
2. Three drawbacks make it unsuitable for anything longer than a short dip.
   1. High interest: the rate is well above the rate on a bank loan, so a business that stays overdrawn month after month loses profit to interest it could have avoided.
   2. Repayable on demand: the bank can reduce or withdraw the limit at short notice, which can leave the owner unable to pay wages in the same week the decision lands.
   3. Charges for going over: exceeding the agreed limit brings fees and refused payments, so a supplier's direct debit bounces and the firm's reputation for paying suffers.

Trade credit: taking the stock now and paying the supplier in 30 days

1. The supplier delivers the goods and issues an invoice, commonly on 30-day terms, and that delay does two things for a small business.
   1. It costs nothing: trade credit is normally interest free, so a £2,000 stock order settled on day 30 costs the same £2,000 it would have cost on the day it arrived.
   2. It funds itself: the business sells the stock before paying for it, so the customers' cash settles the supplier's bill and the owner needs less money of their own tied up in stock.
2. Three drawbacks limit how far a small business can lean on it.
   1. It may not be offered: a new business with no trading record is often refused credit, because the supplier has no evidence the bill will be paid, so a start-up pays cash up front for its first orders.
   2. Late payment costs supply: missing the date damages the relationship, and the supplier can shorten the credit period, put the account on hold or stop delivering, which halts trading altogether.
   3. The discount is lost: many suppliers cut the price for payment inside a few days, so taking the full 30 days quietly raises the cost of every order.

Which one suits a small business: it depends on what caused the gap

1. The two are not rivals for the same job, because each covers a shortfall the other cannot reach.
2. Where the shortfall comes from buying stock, trade credit is the better first choice, because it is free and the goods are often sold before the invoice falls due, so the sale itself pays the supplier and no interest is ever charged.
3. Where wages, rent or a tax bill fall due before customers pay, no supplier is involved and trade credit cannot touch it, so an overdraft is the only one of the two that covers the gap.
4. Levi Roots won £50,000 on Dragons' Den in 2007 and his Reggae Reggae Sauce was stocked by Sainsbury's, and any small producer supplying a chain must make and deliver stock weeks before the payment arrives, which is the wage-bill gap an overdraft exists to carry.
5. So judge it on three things: how large and how long the gap is, what the overdraft interest would cost set against credit that is free, and whether suppliers will offer a business with no trading record any credit at all.