Financing the Short Term Obligations of The Business - Assignment Example

And, the day-to-day operations include payment of wages to employees and payment for inventory as well. Technically speaking, time duration covering the definition of short term finance is of one year. Any short term finance must be repaid within one year period. Following are the four different sources of short term finance available to business: Overdrafts Trade credit Short term loans Lease finance Overdrafts Overdraft means the amount overdrawn from bank (Siddiqui & Siddiqui 2007).Overdrafts are deficits which are financed by the bank.

The overdrafts are results of payments exceeding income in the current account. Overdrafts can easily be availed and remain flexible with regard to the amount borrowed at any point of time and only sum of interest is paid when the account is overdrawn. A particular overdraft limit is set that should not be surpassed. Repayment is carried out on demand and security depends on the facility size or overdraft limit. Trade Credit Trade credit may be defined as credit which is granted on account of transactions of one firm with other firms (Ball 2009).

Trade credit is a type of short term loan. Trade credit represents an interest free short-term loan. And, the main purpose of extending this facility is to enable businesses to purchase current assets on credit with payment terms normally existing between 30 to 90 days. Short term loans A short term loan is a loan for a specified fixed amount for a particular period. It is drawn in toto at the start of the short term loan period and through defined instalments, it is repaid. Some conditions are attached with the short term loan and the borrower is under compulsion to comply with.

Short term loan is not repayable on demand by the bank. The examples of short term loans are trade credit, bank loans and commercial papers (Gitman & McDaniel 2006). Lease finance A business instead of buying an asset outright may lease an asset consuming available resources or borrowing funds. The ownership and control are not availed by businesses. The lessor retains the asset ownership. The lessee enjoys asset possession and use of the leased asset on payment of a particular sum of rentals over a period.

And, operating lease is a form of short term lease (Bhole & Mahakud 2009). Sainsbury and Tesco meeting their short term obligations Companies account for their short term obligations under the label of current liabilities. Sainsbury is using almost every source of short term finance in order to meet its short term obligations in the financial year 2011. Sainsbury uses overdrafts, bank loan, which is due in 2012 and finance lease obligations which are also due in the same year. The closer analysis shows that Sainsbury has used borrowings of 74 million pounds and 59 million pounds from derivative financial instruments.

This shows that the company has used more borrowings than derivative financial instruments (Sainsbury Annual Report 2011). Tesco has also used borrowings and derivative financial instruments to fulfil its day-to-day cash requirements. Tesco borrowed ? 1386 million and ? 255 million were obtained through derivative financial instruments (Tesco Annual Report 2011). In the borrowed figure, finance lease amount was ? 50 million and bank