Advantages and Disadvantages of Commercial Paper

What is a Commercial Paper?

A Commercial Paper (CP) is a short-period 90 to 364 day, unsecured promissory note that is issued by a company to raise funds (usually for the inventories, finance, and temporary liabilities). It is issued by one organization (Primary Dealers (PD) and All-India Financial Institutions (FIs) in India) to another organisation, insurance businesses, pension funds, and banks. The money raised by commercial paper is often huge. Due to the fact that this loan is entirely unsecured, the CP may only be issued by companies with a solid credit rating. 

Advantages of Commercial Paper

Some of the benefits of commercial paper are as follows:

1. Provides Additional Funds: As the cost of the paper to the issuing firm is cheaper than the loans from the commercial bank, it contributes additional funds.

2. Flexible: It is more flexible due to its high liquidity value and wide maturity range. 

3. Reliable: It is quite reliable and free of any restricting conditions. Commercial paper facilitates loan securitization resulting in the formation of a secondary market for paper and the efficient flow of funds from cash surplus to cash shortage businesses.

4. Spend Less: By using commercial paper, businesses may spend less money while still making a profit.

5. Long-term Funding Source: The maturity range may be customised to the company’s needs, and matured papers can be paid for by selling new commercial paper. Companies that are able to raise funding using commercial paper become more well-known in the financial world, putting them in a stronger position to raise as much capital as they need from time to time. As a result, there is an inbuilt incentive for businesses to maintain their financial strength.

Disadvantages of Commercial Paper

Some of the drawbacks of commercial paper are as follows:

1. Difficulty in Raising Capital: Commercial papers may only be used to raise funds by companies that are financially stable and have a good credit rating. As this approach is insecure, it is not suitable for new or moderately rated companies.

2. Capital Restrictions: The amount of money that may be raised through commercial paper is limited.

3. Maturity Period: Commercial paper is an impersonal type of financing, and if a company is unable to redeem its paper due to financial difficulties, extending the maturity of a CP is not feasible.