Business Finance · Financial instruments issued or used by companies

Bank Borrowing, Leasing and Other Short-Term Finance for Companies

Updated 11 October 2026 · Fact-checked

Companies raise debt-like finance from banks (term loans, overdrafts), from asset providers (leasing, hire purchase) and from short-term sources (commercial paper, trade credit). To answer exam questions, identify the need and its time horizon, then compare cost, flexibility, security, tax and risk for each source.

Understand Bank Borrowing, Leasing and Other Short-Term Finance

A company needs money for two broad reasons. Long-term needs buy assets that last, such as plant or buildings. Short-term needs fund day-to-day working capital, such as stock and debtors. A sound rule is to match the term of the finance to the life of what it funds.

A bank term loan is a fixed sum lent for a set period at a fixed or floating rate, repaid in instalments or at the end. It is usually secured on assets and may carry covenants, which are conditions the borrower must keep, such as a maximum gearing level. An overdraft lets the company draw up to an agreed limit on its current account. Interest is charged only on the amount used, but the bank can usually ask for repayment on demand. It suits fluctuating short-term needs, not permanent funding.

Leasing means the company uses an asset owned by someone else (the lessor) and pays rentals. In a finance lease, the lessee takes most of the risks and rewards of ownership, the lease covers most of the asset's life, and the lessee usually maintains and insures it. In an operating lease, the lessor keeps the risks, the period is shorter than the asset's life, and the lessee can often cancel. Under hire purchase, the company pays instalments and ownership passes to it after the last one. Accounting treatment follows the standard in use (Ind AS 116 for lessees), so do not rely on old off-balance-sheet arguments.

Commercial paper is short-term, unsecured, tradable debt issued at a discount by strong, creditworthy companies and repaid at face value. It is usually cheaper than a bank loan but is open only to good credit names. Trade credit is time given by suppliers to pay for goods. It looks free, but giving up an early-payment discount can make it expensive.

Key rules to remember

Annual cost of forgoing a cash discount: Cost = (d ÷ (1 − d)) × (365 ÷ (credit period − discount period)), where d is the discount as a decimal; Simple annualised form. For a compound effective rate use (1 / (1 − d))^(365 ÷ days) − 1.
Discount yield on commercial paper (simple): Yield = ((Face value − Issue price) ÷ Issue price) × (365 ÷ days to maturity); Divide by issue price, not face value. Check the day-count basis stated in the question.
Overdraft interest: Interest = Σ (daily balance overdrawn × rate ÷ 365); You pay only on the amount drawn, for the days it is drawn.
Lease versus buy: Compare PV of after-tax lease payments with PV of after-tax cost of buying, using the after-tax cost of debt; Choose the option with the lower present value of cost. Use the after-tax borrowing rate because leasing replaces borrowing.

How to solve Bank Borrowing, Leasing and Other Short-Term Finance questions

Use this method for both descriptive and numerical questions on short-term and asset-based finance.

1Identify the need: purpose, amount, how long, and whether it is permanent or temporary.
2List the sources that fit the term: overdraft or trade credit for short-term, term loan or lease for medium-term.
3For each source, note cost, security needed, flexibility, repayment terms and covenants.
4Consider tax and accounting effects, such as interest or lease rental deductibility and balance sheet recognition.
5If numbers are given, compute the cost on a comparable annual basis, using the after-tax rate where tax is stated.
6Weigh risks: refinancing risk, interest rate risk, loss of control of assets and credit rating requirements.
7Give a clear recommendation tied to the company's situation and state your assumptions.

Quickest way: Match term, then compare cost and risk

When to use it: Use for MCQs and short written parts asking which source suits a company or how two sources differ.

Short-term and fluctuating need: overdraft, trade credit or commercial paper.
Asset purchase: term loan, finance lease or hire purchase.
Need for flexibility or avoiding obsolescence: operating lease.
Only strong, rated companies can issue commercial paper.
For cost, convert everything to an annual rate before comparing.

Common mistakes in Bank Borrowing, Leasing and Other Short-Term Finance

Saying trade credit is free.
No interest is shown on the invoice.
Fix: Check for a cash discount. Calculate the annual cost of forgoing it and compare with bank interest.
Mixing up finance and operating leases.
Students focus on the name, not on who bears risks and rewards.
Fix: Ask who carries the risks of ownership and whether the lease covers most of the asset's life.
Saying hire purchase never transfers ownership.
It is confused with leasing.
Fix: Remember that ownership passes to the buyer after the final instalment in hire purchase, while a lessee does not normally become owner.
Calculating commercial paper yield on face value.
The discount is measured against face value, so students keep that base.
Fix: The amount invested is the issue price. Divide the gain by the issue price.
Treating an overdraft as long-term finance.
Overdrafts are often renewed year after year.
Fix: State that it is repayable on demand, so relying on it for permanent needs creates refinancing risk.
Using the pre-tax rate in lease-versus-buy discounting.
The tax shield is overlooked.
Fix: Use the after-tax cost of debt when the question includes tax, and include tax relief on payments.

Worked examples

Example 1

A supplier offers terms of 2% discount if you pay within 10 days, otherwise the full amount is due in 40 days. Find the approximate annual cost of forgoing the discount (365-day year, simple basis).

Show the solution

Discount d = 0.02.
d ÷ (1 − d) = 0.02 ÷ 0.98 = 0.020408.
Extra days of credit = 40 − 10 = 30.
Annualise: 365 ÷ 30 = 12.1667.
Cost = 0.020408 × 12.1667 = 0.2483, or about 24.8%.

Answer: About 24.8% a year. If the company can borrow from a bank at a lower rate, it should take the discount.

Example 2

A company issues 91-day commercial paper with face value ₹1,00,00,000 at an issue price of ₹98,00,000. Find the simple annualised yield (365-day basis).

Show the solution

Gain = 1,00,00,000 − 98,00,000 = ₹2,00,000.
Return over the period = 2,00,000 ÷ 98,00,000 = 0.020408.
Annualise: 365 ÷ 91 = 4.01099.
Yield = 0.020408 × 4.01099 = 0.08186.

Answer: About 8.19% a year (simple basis).

Exam tips

Read the question for the term of the need. Many marks go to matching the source to the purpose.
In lease questions, state the test (risks and rewards) before you classify the lease.
When asked to compare sources, use the same headings for each: cost, security, flexibility, risk.
Always annualise before comparing rates, and say which day-count you used.
In written parts, end with a recommendation and one stated assumption.

Practice questions from Financial instruments issued or used by companies

Bank Borrowing, Leasing and Other Short-Term Finance in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Bank Borrowing, Leasing and Other Short-Term Finance: frequently asked questions

What is the difference between a bank loan and an overdraft?

A loan is a fixed sum for a set term, with interest charged on the full amount. An overdraft is a flexible limit where you pay interest only on what you use, but the bank can usually demand repayment at short notice.

What is the difference between a finance lease and an operating lease?

In a finance lease the lessee bears most risks and rewards of ownership and the lease covers most of the asset's life. In an operating lease the lessor keeps those risks, and the period is shorter and often cancellable.

How does hire purchase differ from leasing?

In hire purchase the buyer pays instalments and becomes the owner after the last one. In leasing the lessee pays rentals for use and normally does not become the owner.

Who can issue commercial paper?

Mainly large, creditworthy companies, since it is unsecured. It is issued at a discount and repaid at face value, usually at lower cost than bank borrowing.