intermediate term financing. intermediate term financing refers to borrowings with repayment...
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INTERMEDIATE TERM FINANCING
INTERMEDIATE TERM FINANCING
• Intermediate term financing refers to borrowings with repayment schedules of more than one year but less than ten years. In contrast, short-term financing has a repayment schedule of less than one year, while long-term financing matures in ten years or longer.
ADVANTAGES OF INTERMEDIATE TERM
FINANCING• Intermediate term financing offers the following
advantages to the firm:
– It provides a useful alternative when the firm is unable to continue expanding assets with internal or short-term funds;
– It provides a source of funding for small businesses which do not have ready access to capital markets;
ADVANTAGES OF INTERMEDIATE TERM
FINANCING
• It provides an alternative which at times may be less costly and more convenient than the raising of funds through the flotation of bonds or stocks in capital markets;
ADVANTAGES OF INTERMEDIATE TERM
FINANCING
• Tax advantages are sometimes derived from the exercise. For instance, when a stock issue is used to finance the firm’s operations, the resulting dividends paid to stockholders are not exempted from tax. Interest on term loans, on the other hand, is tax deductible; and
ADVANTAGES OF INTERMEDIATE TERM
FINANCING
• Intermediate term financing allows the firm to borrow funds with only the amounts needed at each stage of financing as required. In effect, the cost of borrowing is minimized as interest will have to be paid only on the actual amount borrowed.
TERM LOANS BY PRIVATE FINANCIAL INSTITUTIONS
• Intermediate term financing is provided by private commercial banks, finance companies, factors, insurance, and pre-need companies.
TERM LENDING BY PRIVATE COMMERCIAL BANKS
• Private commercial banks (PCBs) constitute an easily identifiable source of term loans. The extensive network of branches of PCBs provide easy access to intermediate term credit. – Examples of banks with branches spread all
over the Philippines are the Philippine National Bank and Metropolitan Bank and Trust Company.
TERM LENDING BY PRIVATE COMMERCIAL BANKS
•Term Loan Defined. A term loan is a bank advance for specific period (normally one to ten years) repaid, with interest, usually by regular periodic payments.
TERM LENDING BY PRIVATE COMMERCIAL BANKS
•Types of Term Loan. There are three types of term loan:– Straight term loan;– Revolving credit; and– Evergreen credit.
TERM LENDING BY PRIVATE COMMERCIAL BANKS
• The straight term loan is granted to finance fixed assets. It is also granted to find permanent working capital needs and to temporarily replace liabilities incurred prior to truly long-term financing. The limit for straight term loan is ten years.
TERM LENDING BY PRIVATE COMMERCIAL BANKS
• The revolving credit is a legally assured line of credit, normally extended for two or three year time periods. This is a specific type of line of credit. A line of credit and revolving credit are financial arrangements made between the lending institution and a business or an individual. The lender provides access to funds that you can use at your discretion to make purchases.
• Credit cards - example of revolving credit used by consumers.
TERM LENDING BY PRIVATE COMMERCIAL BANKS
• The evergreen credit is a revolving credit arrangement without a stated maturity.
• Evergreen loans are usually in the form of a short-term line of credit that is routinely renewed leaving the principal remaining outstanding for the long term.
TERM LENDING BY PRIVATE COMMERCIAL BANKS
•Term Loan Agreement. Formal loan agreements are required in the granting of term loans. The loan agreements include the basic features of the loan, such as repayment schedules, interest rates, and maximum commitments.
TERM LENDING BY PRIVATE COMMERCIAL BANKS
• The more common provisions of a loan agreement are the following:– The borrower is required to maintain
a certain amount of working capital or a given current ratio. The purpose of this is the maintenance of a liquidity level enough to repay loan and with sufficient funds for the working capital requirements of the firm.
TERM LENDING BY PRIVATE COMMERCIAL BANKS
• The borrower is required to furnish the bank of the creditor with audited annual financial statements and detailed direct quarterly or monthly statements. This requirement allows the creditor to assess the financial prospects of the borrower and to provide ample warning for the creditor to protect his interests.
TERM LENDING BY PRIVATE COMMERCIAL BANKS
• The borrower is prohibited to sell or dispose his business property, except inventories. The prohibition also includes the pledging of assets to secure other loans.
TERM LENDING BY PRIVATE COMMERCIAL BANKS
• Restrictions are imposed to the borrower regarding cash dividends and a ceiling on officers’ salaries is imposed.
• A restriction is imposed on the borrower regarding the expansion of fixed assets beyond the amount of the term loan. This will prevent the firm and the lender from assuming higher risks brought about by expansion programs.
TERM LENDING BY PRIVATE COMMERCIAL BANKS
• The borrower is required to provide ample insurance coverage to his business properties and key employees. When losses due to perils occur, the borrower is in a better position to settle his obligations than when his business properties and key employees are not adequately covered by insurance.
Term Lending by Private Commercial Banks
• The borrower is prohibited from incurring additional long-term debt or additional lease obligations.
• The borrower is not allowed to repurchase the company’s own stock.
TERM LENDING BY PRIVATE COMMERCIAL BANKS
• Repayment of Term Loans. The repayment of term loans depends upon the nature of the business of the borrower. Majority of ordinary business term loans require equal periodic payments over the life of the loan in amounts adequate to retire the full amount of the principal. The payment schedule is based on the borrower’s projected ability to generate cash.
TERM LENDING BY PRIVATE COMMERCIAL BANKS
• Repayment programs for term loans vary. They consist of the following:– Equal Principal Payments. Under
this arrangement, the loan is repaid in equal amounts of principal. The installments are unequal, however, because the interest payment is largest in the first year and become smaller as the principal is gradually paid.
Sample Problem
• Assume a P100,000 loan payable in 10 years at 8% annual interest
YearOutstanding Principal
at the beginning of the year
Interest due at the end of
the year
Repayment of principal at
the end of the year
Total Payment at
the end of the year
1 100,000 8,000 10,000 18,000
2 90,000 7,200 10,000 17,200
3 80,000 6,400 10,000 16,400
4 70,000 5,600 10,000 15,600
5 60,000 4,800 10,000 14,800
6 50,000 4,000 10,000 14,000
7 40,000 3,200 10,000 13,200
8 30,000 2,400 10,000 12,400
9 20,000 1,600 10,000 11,600
10 10,000 800 10,000 10,800
TERM LENDING BY PRIVATE COMMERCIAL BANKS
• Equal Amortization. The loan is repaid in equal installments under this type of repayment. The amount applied to principal is smallest in the first year, then the same payments to principal gradually increases through the payment years, the largest of which is made on the last year. The decreasing payments on interests, however, equalizes the uneven payments on principal.
YearOutstanding Principal
at the beginning of the year
Interest due at the end of
the year
Repayment of principal at
the end of the year
Total Payment at
the end of the year
1 100,000 8,000 6,902.95 14,902.95
2 93,097.05 7,447.76 7,455.19 14,902.95
3 85,641.86 6851.35 8051.60 14,902.95
4
5
6
7
8
9
10 14,902.95
TERM LENDING BY PRIVATE COMMERCIAL BANKS
•Balloon Payment. Under this repayment program, the loan is repaid in equal installment for a number of years, then, a large and final payment is made at maturity date.
YearOutstanding Principal
at the beginning of the year
Interest due at the end of
the year
Repayment of principal at
the end of the year
Total Payment at
the end of the year
1 100,000 8,000 6,902.95 14,902.95
2 93,097.05 7,447.76 7,455.19 14,902.95
3 85,641.86 6851.35 8051.60 14,902.95
4
5
6
7
8
9
28,701.97
TERM LENDING BY PRIVATE COMMERCIAL BANKS
• Deferred Payment of Principal with Grace Period. The payment of principal under this program is deferred, although payments on interest are made. This repayment program suits loans to finance projects with long gestation periods like new orchard projects and livestock projects.
YearOutstanding Principal
at the beginning of the year
Interest due at the end of
the year
Repayment of principal at
the end of the year
Total Payment at
the end of the year
1 100,000 8,000 8,000
2 100,000 8,000 8,000
3 100,000 8,000 8,000
4 100,000 8,000 11,207.20 19,207.20
5
6
7
8
9
10
• A variation of the deferred payment plan allows the borrower a grace period during which the payment of principal and interest is deferred.
YearOutstanding Principal
at the beginning of the year
Interest due at the end of
the year
Repayment of principal at
the end of the year
Total Payment at
the end of the year
1 100,000 8,000
2 108,000 8,640
3 116,640 9,331.20
4 125,971.20 10,077.69
5 136,048.89 10,883.91 18,616.09 29,500
6
7
8
9
10
TERM LENDING BY INSURANCE COMPANIES
• Insurance companies are important source of term loans. The premiums generate constitute advances to the insurance companies for periods varying from six months to five or more years. This gives rise to funds held for policy holders by the insurer, funds that must be invested in some manner.
TERM LENDING BY INSURANCE COMPANIES
• The Insurance Code specifies the areas of investments allowed for insurance companies. Intermediate term lending is included in the provision.
TERM LENDING BY FINANCE COMPANIES
• Business firms may also obtain intermediate or medium-term financing from finance companies. Funds which ma be derived from such borrowings may be used form the following purposes:– As additional working capital;– For the purchase of machinery and
equipment;
TERM LENDING BY FINANCE COMPANIES
• For the construction of additional plant facilities;
• For the retirement of maturing securities;
• For buying out partners or stockholders; and
• For the purchase of other companies.
TERM LENDING BY FINANCE COMPANIES
• Finance companies have developed special installment financing plans for firms acquiring machinery and equipment. Under the arrangement, a down payment s required and the balance is paid to the finance company in installments designed to fit the needs and depreciation schedule of the firm buying the machinery and equipment.
TERM LENDING BY THE GOVERNMENT
• The government seeks to identify investment areas which require financial assistance. This is done for the purpose of achieving development objectives. To realize this, the operations of certain kinds of business firms are financed by the government. A sizeable portion of the loans granted are intermediate term.
TERM LENDING BY THE GOVERNMENT
• Most of the financial assistance provided by the government are coursed through private and government financial institutions. The funding schemes are designed and redesigned from time to time to suit the government’s particular objectives in development. The Guarantee Fund for Small and Medium Enterprises is an example of such funding projects.
TERM LENDING BY THE GOVERNMENT
• Government financial institutions have become sources of intermediate loans. Among them are the Land Bank of the Philippines, the Development Bank of the Philippines, the Social Security System, the Government Service Insurance System, and some others.