What are some examples of unsecured and secured sources of short-term credit?

Question

What will be an ideal response?

Answer 1

Short-term credit sources can be classified into two basic groups: unsecured and secured. Unsecured loans include all
those sources that have as their security only the lender's faith in the ability of the borrower to repay the funds when
due. The major sources of unsecured short-term credit include accrued wages and taxes, trade credit, unsecured bank
loans, and commercial paper. A secured loan involves the pledge of specific assets as collateral in the event the
borrower defaults in payment of principal or interest. Commercial banks, finance companies, and firms that make
loans secured by receivables (factors) are the primary suppliers of secured credit. The principal sources of collateral
include accounts receivable and inventories.
Because most businesses pay their employees only periodically (weekly, biweekly, or monthly), firms accrue a
wages-payable account that is, in essence, a loan from their employees. Similarly, firms generally make quarterly
income tax payments for their estimated quarterly tax liability. This means that the firm has the use of the tax money it
owes based on its quarterly profits through the end of the quarter. Trade credit provides one of the most flexible
sources of short-term financing available to the firm. Trade credit arises spontaneously with the firm's purchases.
Commercial banks provide unsecured short-term credit
Commercial paper is simply a short-term promise to pay that is sold in the market for short-term debt securities.
Secured sources of short-term credit have certain assets of the firm pledged as collateral to secure the loan. Upon
default of the loan agreement, the lender has first claim to the pledged assets in addition to its claim as a general
creditor of the firm. Hence, the secured credit agreement offers an added margin of safety to the lender. Under the
pledging accounts receivable arrangement, the borrower simply pledges accounts receivable as collateral for a loan
obtained from either a commercial bank or a finance company. Inventory loans, or loans secured by inventories,
provide a second source of security for short-term credit. The amount of the loan that can be obtained depends on both
the marketability and perishability of the inventory.