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HMRC internal manual

Corporate Finance Manual

HM Revenue & Customs
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Understanding corporate finance: raising finance: short-term borrowing

Short term borrowing

For short-term working capital a company may have agreed overdraft facilities with its bank, subject to an agreed limit. Interest will normally be calculated at a variable rate. Lenders normally charge arrangement fees, though there may be a trade-off between the amount of the fee and the interest margin. Overdraft facilities are provided for a fixed period, normally of no more that one year, when they are reviewed and renewed as appropriate. All overdraft facilities are repayable on demand, and though they may be secured through security held by the lender, are not normally subject to covenants which would impair the on-demand nature of the facility.

Other sources of short-term funding may include (for a company that issues invoices on credit terms), invoice discounting (borrowing against an agreed percentage of the outstanding balance of its invoices, and invoice factoring (where the factor pays an agreed percentage of an invoice and then collects the debt). Banks will also offer bridging loans to cover a short-term funding gap between, for example, buying a new asset and selling a current asset. Stocking finance may also be obtained especially for businesses with highly seasonal stock requirements, with the lender either retaining ownership of the stock until just before sale or use, or limiting the facility to an agreed percentage of the stock held by the borrower. Stocking finance may not necessarily be denominated in sterling or currency, for example, loans of precious metals such as gold, where there is a readily available market price.

Commercial bills and commercial paper

Larger companies may issue commercial bills or commercial paper. Every day, businesses generate pieces of paper that provide evidence of a right to receive a sum of money. If a trader sells goods to a customer and the customer gives the supplier an IOU, the supplier could sell the right to collect the payment from the customer. This gives the supplier a means of raising cash before the date the IOU is due to be honoured. These pieces of paper, or IOUs, are commercial bills.

Commercial paper is a kind of commercial bill a company uses to raise finance when it has not supplied any goods or services. Commercial paper is evidence that it will make a payment of a specified amount at a specified time itself. Another party buys this piece of paper. In this way the company raises cash. Whoever holds the piece of paper at the due date for payment collects the money.

Clearly the price paid by the buyer will be less than the amount which will be paid out when the bill matures. A right to receive £100 in 12 months will be worth less than a right to receive £100 now.

Commercial paper is unsecured, and may be discounted or interest-bearing. It is used to raise short-term finance, and typically is issued for periods up to 270 days. The average life of commercial paper in Britain is about 40 days. A company may extend the borrowing by effectively rolling it over - issuing further paper to raise funds to cover the repayment of the original borrowing, and thereby use commercial paper as a means of medium-term borrowing.

It is usually issued by companies with good credit ratings, and from the investor’s point of view is relatively low risk.