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Chapter 11Chapter 11

Short-TermShort-Term

FinancingFinancing

Instructor: Ajab Khan Burki


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11-2

Short-Term FinancingShort-Term Financing

Spontaneous Financing

Negotiated Financing Factoring Accounts

Receivabe

!omposition o" Short-TermFinancing


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Spontaneous FinancingSpontaneous Financing

Accounts #a$abe%Trade !redit "rom Suppiers&

Accrued '(penses

T$pes o" spontaneousT$pes o" spontaneous

"inancing"inancing


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,ra"t,ra"t-- A signed* )ritten order b$ )hich the

"irst part$ %dra)er& instructs a second part$%dra)ee& to pa$ a speci"ied amount o" mone$to a third part$ %pa$ee&+ The dra)er andpa$ee are o"ten one and the same+

Trade Acceptances: the seer dra)s a draftdraftonthe bu$er that orders the bu$er to pa$ the dra"t

at some "uture time period+


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Terms of the SaleTerms of the Sale

Net Period - No Cash DiscountNet Period - No Cash Discount

-- )hen credit is

e(tended* the seer speci"ies the period o" timeao)ed "or pa$ment+ Net ./0 impies "upa$ment in ./ da$s "rom the invoice date+

CODCODandand CDCD- No Trade Credit: the bu$erpa$s cash on deli!erycash on deli!ery or cash before deli!erycash before deli!ery+

This reduces the seer1s risk under CODCODto thebu$er re"using the shipment or eiminates itcompete$ "or !B,+


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Terms of the SaleTerms of the Sale

Seasonal DatingSeasonal Dating-- credit terms that encourage thebu$er o" seasona products to take deiver$ be"orethe peak saes period and to de"er pa$ment untia"ter the peak saes period+

Net Period - Cash DiscountNet Period - Cash Discount-- )hen credit ise(tended* the seer speci"ies the period o" timeao)ed "or pa$ment ando""ers a cash discount i"

paid in the ear$ part o" the period+ 234/* net ./0impies "u pa$ment )ithin ./ da$s "rom the invoicedate ess a 25 discount i" paid )ithin 4/ da$s+


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Trade Credit as aTrade Credit as a

"eans of Financing"eans of Financing

64*/// ( ./ da$s 7 6./*/// account baance

8hat happens to accounts pa$abe i" a8hat happens to accounts pa$abe i" a

"irm purchases 64*///3da$ at net ./09"irm purchases 64*///3da$ at net ./09

8hat happens to accounts pa$abe i" a8hat happens to accounts pa$abe i" a

"irm purchases 64*//3da$ at net ./09"irm purchases 64*//3da$ at net ./0964*// ( ./ da$s 7 6;*/// account baance

A #1$%&&& increase from operationsA #1$%&&& increase from operations''


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Cost to Forgo a DiscountCost to Forgo a Discount

Appro(imate annua interest cost 7

5 discount .


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Appro(imate annua interest cost 7

25 .?& ( %.


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#a$ment ,ate#a$ment ,ate Annua rate o" interestAnnua rate o" interest

44 @;;+>5

2/ @;+ ././ .@+2.@+2 >/ >+. da$s "rom invoice date


The appro(imate interest cost over aThe appro(imate interest cost over a

variet$ o" pa$ment decisions "orvariet$ o" pa$ment decisions "or

234/* net 234/* net +0+0


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S-t-r-e-t-c-h-i-n-gS-t-r-e-t-c-h-i-n-g

Account PayablesAccount Payables

!ost o" the cash discount %i" an$& "orgone

Cate pa$ment penaties or interest

,eterioration in credit rating

#ostponing pa$ment be$ond the end o" the#ostponing pa$ment be$ond the end o" the

net period is kno)n asnet period is kno)n as stretching accountsstretching accounts

pa$abe0pa$abe0 or eaning on the trade+0or eaning on the trade+0#ossibe costs#ossibe costs o"o" stretchingstretching

accounts pa$abe0accounts pa$abe0


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Ad!antages ofAd!antages of

Trade CreditTrade Credit

!onvenience and avaiabiit$ o"

trade credit Dreater "e(ibiit$ as a means o"

"inancing

!ompare costs o" "orgoing a possibe!ompare costs o" "orgoing a possibe

cash discount against the advantagescash discount against the advantages

o" trade credit+o" trade credit+


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(ho ears the Cost of(ho ears the Cost of

Funds for Trade Credit)Funds for Trade Credit)

Bu$ersBu$ers-- )hen costs can be "u$passed on through higher prices to the

bu$er b$ the seer+ BothBoth-- )hen costs can partia$ be

passed on to bu$ers b$ seers+

SuppiersSuppiers-- )hen trade costs cannotbe passed on to bu$ers because o"

price competition and demand+


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Eone$ Earket !reditEone$ Earket !redit !ommercia #aper

Bankers1 Acceptances

nsecured Coansnsecured Coans Cine o" !redit

Revoving !redit Agreement

Transaction Coan

T$pes o" negotiated "inancingT$pes o" negotiated "inancing:


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,,Stand-AloneStand-Alone

Commercial PaperCommercial Paper

!ommercia paper market is composed o" the!ommercia paper market is composed o" the%4& deaer and %2& direct-pacement markets+

AdvantageAdvantage: !heaper than a short-term

business oan "rom a commercia bank+

,eaers reGuire a ine o" creditine o" credit to ensure thatthe commercia paper is paid o""+

Commercial PaperCommercial Paper-- Short-term* unsecuredpromissor$ notes* genera$ issued b$ argecorporations %unsecured corporate IHs&+


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,,an.-Supportedan.-Supported

Commercial PaperCommercial Paper

Cetter o" credit %C3!&Cetter o" credit %C3!& -- A promise "rom athird part$ %usua$ a bank& "or pa$mentin the event that certain conditions are

met+ It is "reGuent$ used to guaranteepa$ment o" an obigation+

Best "or esser-kno)n "irms to accesso)er cost "unds+

A bank provides a etter o" creditetter o" credit* "or a "ee*

guaranteeingguaranteeingthe investor that the compan$1sobigation )i be paid+


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an.ers/ Acceptancesan.ers/ Acceptances

sed to "aciitate "oreign trade or theshipment o" certain marketabe goods+

CiGuid market provides rates simiar tocommercia paper rates+

an.ers/ Acceptancesan.ers/ Acceptances-- Short-termpromissor$ trade notes "or )hich a bank %b$having accepted0 them& promises to pa$the hoder the "ace amount at maturit$+


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Short-TermShort-Term

usiness 0oansusiness 0oans

Secured 0oansSecured 0oans-- A "orm o" debt "or

mone$ borro)ed in )hich speci"icassets have been pedged to guaranteepa$ment+

nsecured 0oansnsecured 0oans-- A "orm o" debt "ormone$ borro)ed that is not backed b$

the pedge o" speci"ic assets+


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nsecured 0oansnsecured 0oans

Hne-$ear imit that is revie)ed prior to rene)a todetermine i" conditions necessitate a change+

!redit ine is based on the bank1s assessment o"the credit)orthiness and credit needs o" the "irm+

!eanup0 provision reGuires the "irm to o)e the

bank nothing "or a period o" time+

0ine of Credit 23ith a ban.40ine of Credit 23ith a ban.4-- An in"ormaarrangement bet)een a bank and itscustomer speci"$ing the ma(imum amount o"

unsecured credit the bank )i permit the "irmto o)e at an$ one time+


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Firm receives revoving credit b$ pa$ing a

commitment "eecommitment "ee on an$ unused portion o" thema(imum amount o" credit+

!ommitment "ee!ommitment "ee -- A "ee charged b$ the ender "oragreeing to hod credit avaiabe+

Agreements "reGuent$ e(tend be$ond 4 $ear+

5e!ol!ing Credit Agreement5e!ol!ing Credit Agreement-- A "orma* egacommitment to e(tend credit up to some

ma(imum amount over a stated period o" time+


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'ach reGuest is handed as a separatetransaction b$ the bank* and project oandetermination is based on the cash-"o) abiit$

o" the borro)er+

The oan is paid o"" at the competion o" theproject b$ the "irm "rom resuting cash "o)s+

Transaction 0oanTransaction 0oan-- A oan agreementthat meets the short-term "unds needs o"

the "irm "or a singe* speci"ic purpose+


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Detour6Detour6 Cost of orro3ingCost of orro3ing

,i""erentia "rom prime depends on:

!ash baances Hther business )ith the bank

!ost o" servicing the oan

7nterest 5ates7nterest 5ates

#rime Rate -- Short-term interest rate chargedb$ banks to arge* credit)orth$ customers+


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64/*/// in interest64//*/// in usabe "unds


Computing 7nterest 5atesComputing 7nterest 5ates

!oect Basis!oect Basis-- interest is paid at maturit$ o"the note+

'(ampe: 64//*/// oan at 4/5stated interest rate "or 4 $ear+

7 4/+//5


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64/*/// in interest6>/*/// in usabe "unds


Computing 7nterest 5atesComputing 7nterest 5ates

,iscount Basis,iscount Basis-- interest is deducted "romthe initia oan+

'(ampe: 64//*/// oan at 4/5stated interest rate "or 4 $ear+

7 44+445


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64//*/// in interest6?/*/// in usabe "unds


Compensating alancesCompensating alances

Non-interest-bearing demand deposits maintained b$

a "irm to compensate a bank "or services provided*credit ines* or oans+

'(ampe: 64*///*/// oan at 4/5 stated interest rate "or4 $ear )ith a reGuired 64/*/// compensating baance+

7 44+@


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Commitment FeesCommitment Fees

The "ee charged b$ the ender "or agreeing to hod

credit avaiabe is on the unused portions o" credit+

'(ampe: 64 miion revoving credit at 4/5 statedinterest rate "or 4 $ear borro)ing "or the $ear )as6


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6


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SecuredSecured

2or Asset-ased4 0oans2or Asset-ased4 0oans

Earketabiit$ Ci"e

Riskiness

Securit$ %coatera&Securit$ %coatera&-- Asset %s& pedged b$a borro)er to ensure repa$ment o" a oan+I" the borro)er de"auts* the ender ma$se the securit$ to pa$ o"" the oan+

!oatera vaue depends on!oatera vaue depends on:


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niform Commercial Codeniform Commercial Code

Securit$ interests o" the ender

Securit$ agreement %device&

Fiing o" the securit$ agreement

Eode state egisation reated to man$aspects o" commercia transactions that)ent into e""ect in #enns$vania in 4>;+ Ithas been adopted )ith imited changes b$most state egisatures+

Artice > o" the !ode deas )ithArtice > o" the !ode deas )ith:


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Accounts-5ecei!able-Accounts-5ecei!able-

ac.ed 0oansac.ed 0oans

Noti"icationNoti"ication-- "irm customers are noti"iedthat their accounts have been pedged to theender and remittances are made direct$ tothe ending institution+

T$pes o" receivabe oan arrangementsT$pes o" receivabe oan arrangements:

Nonnoti"icationNonnoti"ication-- "irm customers are not

noti"ied that their accounts have beenpedged to the ender+ The "irm "or)ards apa$ments "rom pedged accounts to theender+


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7n!entory-ac.ed 0oans7n!entory-ac.ed 0oans

Earketabiit$ #erishabiit$

#rice stabiit$

,i""icut$ and e(pense o" seing "or oansatis"action

!ash-"o) abiit$

Reative$ iGuid asset accounts

Coan evauations are made onCoan evauations are made on:


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Types ofTypes of


Foating CienFoating Cien -- A genera* or banket*ien against a group o" assets* such as

inventor$ or receivabes* )ithout theassets being speci"ica$ identi"ied+

!hatte Eortgage!hatte Eortgage -- A ien on

speci"ica$ identi"iedpersonalproperty%assets other than rea estate&backing a oan+


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Types ofTypes of


Trust ReceiptTrust Receipt -- A securit$ deviceackno)edging that the borro)er hods

speci"ica$ identi"ied inventor$ andproceeds "rom its sae in trust "or theender+

Termina 8arehouse ReceiptTermina 8arehouse Receipt -- A

receipt "or the deposit o" goods in apubic )arehouse that a ender hodsas coatera "or a oan+


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Types ofTypes of


Fied 8arehouse ReceiptFied 8arehouse Receipt -- Areceipt "or goods segregated andstored on the borro)er1s premises%but under the contro o" anindependent )arehousingcompan$& that a ender hods ascoatera "or a oan+


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FactoringFactoring

Accounts 5ecei!ableAccounts 5ecei!able

FactorFactoris o"ten a subsidiar$ o" a bank hodingcompan$+

FactorFactormaintains a credit department and per"ormscredit checks on accounts+

Ao)s "irm to eiminate their credit departmentand the associated costs+

!ontracts are usua$ "or 4 $ear* but are rene)abe+

FactoringFactoring-- The seing o" receivabes to a"inancia institution* the factorfactor* usua$)ithout recourse+0


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FactoringFactoring

Accounts 5ecei!ableAccounts 5ecei!able

Factor receives a commission on the "ace vaue o"the receivabes+

!ash pa$ment is usua$ made on the actua oraverage due date o" the receivabes+

I" the "actor advances mone$ to the "irm* then the"irm must pa$ interest on the advance+

Tota cost o" "actoring is composed o" a "actoring"ee pus an interest charge on an$ cash advance+

Athough e(pensive* it provides the "irm )ithsubstantia "e(ibiit$+

Factoring !ostsFactoring !osts


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Composition ofComposition of

Short-Term FinancingShort-Term Financing

!ost o" the "inancing method Avaiabiit$ o" "unds

Timing

Fe(ibiit$

,egree to )hich the assets areencumbered

The best mi( o" short-termThe best mi( o" short-term

"inancing depends on:"inancing depends on:

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