chapter-3_mode of financing

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Mr. SafeerullahLecturer in Finance

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Mode of Financing

Short-Term Financing:Short-term financing refers to debt originall scheduled for re!ament "ithin oneear. Short-term financing is used to finance all !arts of the firm#s "or$ing ca!ital

re%uirements and sometimes to meet !ermanent financing needs.

Un-secured Short Term Financing:

&t is an obligation "ithout s!ecific assets or !ledged as collateral. 'ollateral is the

asset that the borro"er !ledges to lender until a loan is re!aid.

Secured Short Term Financing:

&t is an obligation "ith a s!ecific asset !ledged as collateral until a loan is re!aid.

Firms (btain short-term financing from se)eral resources.

(ther business firms. e.g. credit or commercial !a!er.

Financial intermediaries. *.g. +an$, insurance com!anies, !ension funds

etc.

&ndi)idual.

Spontaneous Sources:

S!ontaneous sources of short-term financing are sources that arise automaticall

from ordinar business transaction. he do not re%uire s!ecial efforts ornegotiation on the !art of financial manager. he t"o maor sources of

s!ontaneous sources are account !aables and accruals.

he le)el of s!ontaneous credit is a function of the firm#s o!eration as sales

increases, current liabilities t!icall increase.

Negotiated Sources:

/egotiated sources of short-term financing are sources that re%uire s!ecial efforts

and negotiation. he maor sources of negotiated short-term credit are +an$ loans,

commercial !a!ers, account recei)able loans and in)entor loans.

Trade Credit:

rade credit is a short-term credit etended b su!!lier of goods and ser)ices and

subect to certain terms and conditions. rade credit results "hen a firm ac%uires

su!!lies, materials and does not !a for them immediatel. hese transactions are

t!icall recorded on the balance sheet as account !aable or notes !aable.

/S& &nstitute of Management Sciences Mardan

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hree maor t!es of trade credit

ccount aable (!en account6.

/otes aable.

rade cce!tance.

he s!ecific nature of account !aable is determined b four factors.

'redit erm

/ature of !roduct.

Seller#s financial !osition.

+uer#s financial !osition.

Stretching ccounts aables

&t is the !ost!onement of !ament beond he end of credit !eriod.

ccrualsccruals are current liabilities for ser)ices recei)ed but for "hich com!lete

!aments ha)e not been made. ccruals include "ages, taes, rent, interest!aables.

erm Financing erm Loans6erm financing is for more than fi)e ears. &n term financing the interest rate is

higher than short term financing.

d)antages

S!eed

Fleible

Lo" insurance cost

7isad)antages

ro)isions agreements, restrictions b lender6.

'ash drain

'ost

ro)isions

1. eneral ro)isions

9or$ing ca!ital re%uirements.

'ash di)idend and re!urchase of common stoc$.


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'a!ital e!enditure.

2. :outine ro)isions

Financial Statements

&nsurance !ament

/egati)e !ledge clause.

*%ui!ment Financing Loan&t is a loan used to finance the !urchase of ne" e%ui!ment in "hich the e%ui!ment

is used as collateral for the loan.

"o !es

1. 'onditional Sale 'ontract

conditional sale contract is a financing agreement in "hich the seller of

e%ui!ment retains the title of e%ui!ment until all !aments ha)e been made.

2. 'hattel Mortgage

&t is a lien on !ersonal !ro!ert "hich gi)es the lender the right to sei;e or

sell the e%ui!ment in the e)ent of default on the borro"er.

Lease:Lease is a contractual agreement in "hich the asset#s o"ner leaser6 agrees to let

another !art lessee6 use that asset in accordance "ith the terms of a contract.

"o maor t!es

1. (!erating Leasen o!erating lease sometimes called a ser)ice or maintenance lease. &t is a

short-term cancelable agreement that !ro)ides the lessee "ith use of an

asset on a !eriod b !eriod base.

2. Financial Lease 'a!ital Lease6suall !referred stoc$ holder has no )oting right.

:etirement of referred Stoc$

/o definite date.

'all feature.

Sin$ing fund !ro)ision.

'on)ertible into common stoc$.

7i)idend.


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3. Develop short-term financial Plans:Short-term financial !lans reflect e!ected short-term financial outcome

and acti)it and it generall co)ers t"o ears !eriod. Sales forecast ser)e as

in!uts to short-term !lan.

4. Develop individual udgets:

budget is a financial e!ense of management#s !lan. +udgets s!ecif the

resources re%uired to achie)e the goal and ser)e as !erformance standards

against "hich o!erations are e)aluated and adusted. /umerous indi)idual

budgets are !re!ared including sales, !roduction, selling e!ense,

administrati)e budget.

!. Develop consolidated udget:

&ndi)idual budgets are then combined to form a single consolidated budget.

his is used in turn to !re!are !roected cash budgets and !roforma

financial statements.

Financial Forecasting:&t is the !rocess of !roecting or estimating some future financial e)ents or

conditions of a firm. &t ser)es as the basis for establishing budget, estimating

future financial needs and maintaining a firm#s financial affairs.

he forecasting !rocess generall begins "ith the sale forecast. sale forecast is

an estimate of a firm#s sales for a s!ecified future date.

Limitations in Financial Planning:

1. Not exact Forecasting:

+eing based on financial forecasts, no financial !lan can eactl !redict the

future economic and business en)ironment. &f forecasting is "rong, the

financial !lan "ould be ineffecti)e. herefore, a financial !lan should be

!eriodicall re)ie"ed and necessar changes must be made in accordance"ith the changing economic and business en)ironment.

2. Lack of co-ordination:

&f there is not effecti)e co-o!eration and co-ordination among )arious

officials of the cor!oration, it is difficult to im!lement e)en the ideal

financial !lan successfull, and the financial !lan !ro)es unsuccessful and

ineffecti)e.


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3. Changes in Economic Conditions and Govt. Poicies:

'hanges in economic condition and go)ernment !olicies eert ad)erseinfluence on the effecti)eness of a financial !lan.

!. "igid #ie$:

&f the financial managers follo" a rigid )ie" regarding the financial !lan of

cor!oration, and hesitate in ma$ing necessar adustments in it effecti)e

financial !lan also become ineffecti)e for "ant of necessar adustment

according to the changing economic and business conditions.

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