CIPS Exam L6M2 Topic 2 Question 14 Discussion

Sources of Short-Term Funding for XYZ Airline

Introduction

XYZ, an airline with severe financial losses due to a two-year pandemic, requires short-term funding to maintain operations. With cash reserves at an all-time low, the airline needs immediate working capital to cover employee salaries, aircraft maintenance, airport fees, and fuel costs.

Short-term funding options provide temporary liquidity but come with different risks and costs. This answer evaluates four sources of short-term funding and recommends the best option for XYZ.

1. Bank Overdraft (Flexible Borrowing Facility)

Explanation

A bank overdraft allows XYZ to withdraw funds beyond its available balance, up to a set limit.

Advantages

Flexible borrowing -- Funds can be accessed as needed.

Quick to arrange -- Available through existing bank relationships.

Interest only on borrowed amount -- No need to take a large loan upfront.

Disadvantages

High-interest rates -- Overdrafts often have higher interest than standard loans.

Limited borrowing capacity -- May not be enough to cover all costs.

Bank may demand repayment at short notice.

Best for: Covering minor cash flow shortages but not large-scale operational funding.

2. Short-Term Business Loan (Fixed-Term Borrowing from a Bank or Lender)

Explanation

A short-term loan provides a lump sum of cash that XYZ must repay over a set period (typically 3-12 months).

Advantages

Larger funding amounts available -- More substantial than overdrafts.

Predictable repayment terms -- Fixed monthly payments help with planning.

Can be secured or unsecured -- Secured loans offer lower interest rates.

Disadvantages

Requires repayment even if revenue is still low.

Potentially high interest rates, especially for unsecured loans.

Approval process may take time.

Best for: Covering larger operational costs like aircraft maintenance and staff salaries.

3. Sale and Leaseback of Assets (Liquidity from Selling Existing Assets)

Explanation

XYZ can sell its aircraft or other assets to an investor or leasing company and then lease them back for continued use.

Advantages

Immediate cash injection without losing operational assets.

No repayment burden -- Unlike loans, it does not increase debt levels.

Improves cash flow for essential expenses.

Disadvantages

Long-term cost increase -- Leasing is more expensive than owning in the long run.

Loss of asset ownership -- Limits financial flexibility in the future.

Dependent on market conditions -- Aircraft resale values fluctuate.

Best for: Raising large capital quickly while continuing operations.

4. Government Grants or Emergency Aid (Public Sector Financial Assistance)

Explanation

Governments often provide financial aid or grants to struggling industries, especially airlines affected by global crises.

Advantages

No repayment required -- Unlike loans, grants do not need to be repaid.

Low risk -- Does not increase financial liabilities.

Supports industry stability -- Governments want airlines to survive for economic reasons.

Disadvantages

Lengthy approval process -- Bureaucratic delays may not provide immediate relief.

Strict eligibility requirements -- XYZ must meet conditions set by the government.

Potential public criticism -- Bailouts may attract negative media attention.

Best for: Long-term financial recovery rather than immediate short-term cash flow issues.

5. Recommendation: Best Source for XYZ

Recommended Option: Sale and Leaseback of Assets

Why?

Provides immediate liquidity -- Essential for covering urgent operational costs.

No additional debt burden -- Unlike loans, it does not create financial liabilities.

Ensures business continuity -- XYZ can still operate leased aircraft.

Secondary Option: Short-Term Loan

If sale and leaseback is not viable, a short-term business loan can be used for emergency liquidity, but it increases financial risk.

Final Takeaway:

Sale and Leaseback Best for quick large-scale funding without debt.

Short-Term Loan A backup option if leasing is unavailable.