Short-term Funding Choices

Regular assessment of short-term funding aims to ensure that a company has the ability to handle peak cash needs and maintain sufficient sources of credit to fund ongoing cash needs.

Short-term Funding

The short-term funding alternatives that are available to a company may be divided into bank sources and non-bank sources.

Bank sources of funding include:

  • Uncommitted lines of credit – this is the weakest form of bank borrowing as it involves no formal commitment from the bank;
  • Regular lines of credit – these are stronger than uncommitted lines due to the presence of a formal bank commitment;
  • Overdraft lines;
  • Revolving credit agreements – these are the strongest form of short-term bank borrowing facilities and have formal legal agreements;
  • Collateralized loans – These loans involve the borrower putting up collateral in the form of an asset;
  • Discounted receivables;
  • Banker’s acceptances; and
  • Factoring

Non-bank sources of funding include:

  • Non-bank finance companies; and
  • Commercial paper

Recommending a Financing Method

In selecting from several short-term funding options, a company has to select the one which is most cost-effective. In determining the cost of borrowing for comparability, the total cost of borrowing for each option is divided by the total loan proceeds, adjusting for any discounting or compensating balances.

For a line of credit which requires payment of a commitment fee:


If however the interest rate is stated as “all-inclusive” and the loan amount includes the amount of interest, for example in the case of banker’s acceptances, the formula is adjusted as follows:


If the borrowing arrangement is all inclusive and involves a dealer’s commission and backup costs, for example in the case of commercial paper, the formula is again adjusted as follows:


It is important to keep the time periods for the loan proceeds and interest payments consistent during the computation.


A company is evaluating three options for borrowing $5 million for one month:

  • A line of credit at 8% with a ½% commitment fee on the full amount with no compensating balances;
  • A banker’s acceptance at an all-inclusive rate of 7.8%; and
  • Commercial paper at 7.4% with dealer’s commission of ¼% and backup costs of 1/3%.

Which of these forms of borrowing has the lowest cost of credit?

A. Commercial paper

B. Line of credit

C. Banker’s acceptance


The correct answer is C.

For the line of credit:



For the banker’s acceptance:



For the commercial paper:



We multiply by 12 in each of the calculations in order to get an annual rate. Since the 7.85% cost for the banker’s acceptance is the lowest of the three costs, the banker’s acceptance has the lowest cost of credit.


Reading 37 LOS 37g:

Evaluate the choices of short-term funding available to a company and recommend a financing method


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