short term financing-lin wen
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Short Term FinancingShort Term Financing
InstructorLin Wen
2006
OutlineOutlineShort Term v. Long Term FinancingNeed For Short Term (S-T) FinancingTypes of S-T Financing
Business LoansTrade CreditCommercial PaperFactoring
Calculation Methods for S-T FinancingCollateral AnalysisDebt Service Analysis in S-T Financing
Short Term v. Long Term Short Term v. Long Term FinancingFinancing
Short Term Financing:Less than one (1) year period
Long Term Financing:More than one (1) year period
Short Term v. Long Term Financing Short Term v. Long Term Financing (Example)(Example)
Short Term Long Term
Seasonal purchases (Inventory, supplies,
etc..)Business Expansion
(e.g. Open a second store)
Receivables from salesPurchasing Commercial Real
Estate
Payroll Expenses Purchasing Business
Advertising Expenses Establish business
Purchasing new or used business equipment
Purchasing Vehicles
Why Short Term (S-T) Financing?
Profits may not be sufficient to keep up with growth-related financing needs.Firms may prefer to borrow now for their needs rather than wait until they have saved enough.Short-term financing instead of long-term sources of financing due to:
easier availabilityusually lower cost
Types of S-T Financing
Business Loans
Trade Credit
Commercial Paper
Factoring
Business LoansConcept: Borrowing from banks or other financial institutions for short and long term financing.
Use of FundsMonthly Payment
Line of Credit Short Term Working
CapitalSeasonal
PurchasesBusiness Supplies
Capital LoanLong Term working
CapitalBusiness
ExpansionRefinance Existing
Debt
Equipment Loan
Purchase or refinance new/used business equipment
Principal and interest monthly
Vehicle Loan
Purchase or refinance new/used business vehicles
Principal and interest monthly
Interest Monthly, principal at maturity.
In some cases: Principal +
Interest monthly
Principal and interest monthly
Trade CreditConcept: Borrowing from suppliers
Trade credit is the act of obtaining funds by delaying payment to suppliers.
Even though it is obtained by simply delaying payment, it is not always free.
The cost of trade credit may be some interest charge that the supplier charges on the unpaid balance. More often, it is in the form of a lost discount that would be given to firms who pay earlier.
Credit has a cost. That cost may be passed along to the customer as higher prices, absorbed by the seller as lower profits, or some of both.
Concept: Available to large credit- worthy businesses.
Business issues notes to the public and finances its short term needs
Notes can be issued between 30 days and 360 days
Principal and interest is due by the end of maturity
Commercial Paper
FactoringConcept: Borrowing from factoring companies by selling Accounts Receivables arising from sales
Factoring companies collect the interest in advanceFlat fee is paid in advanceFlat fee covers administrative expenses for A/RsFactoring agreements can be “With-Recourse” or “Without-Recourse”Without-Recourse agreements are costly than With-Recourse ones (High risk, High premium)
Factoring
“With Recourse”Factoring company is not responsible to
collect delinquent receivables
“Without Recourse”Factoring company has to collect
delinquent accounts
Interest Rate Calculations
$Net Amount $ Final Payment of Financing
I---------------------t days-----------------------------------------
$ Interest for t days = Final Payment – Net Amount of Financing
Final Payment- Net Amount of Financing% Interest for t days = ---------------------------------------------------
Net Amount of Financing
Interest Rate Calculations (Example)
$ 1,000 $1,010
I---------------------30 days---------------------------------------
$ Interest for 30 days = $1,010 – $1,000 = $10
$1,010 – $1,000% Interest for 30 days = ---------------------
$1,000 = 1% (for 30 days only!!!)
Simple Interest v. Compound Interest
Simple Annual Interest =
(Final Payment- Net Amount of Financing) 360 --------------------------------------------------- X -------- (Net Amount of Financing) t
($1,010 – 1,000) 360Example = ------------------- X --------- = 12% $1,000 30
Effective (Compound) Annual Interest =
Final Payment ---------------------------------- - 1 Net Amount of Financing
$1,010 Example = ------------------- - 1 = 1.1268 - 1 $1,000
= 0.1268 or 12.68%
Simple Interest v. Compound Interest
360t
36030
Concept: Effective Interest Rate is used to determine the cost of the credit to be able to compare differing terms.
Coffee Time…
Interest Calculation Methods S-T Financing
Business LoansIn terms of payment method, business loans are classified as
Term Loans: Principal and Interest monthly (Usually for long term financing, however, in some
cases, it can be used for short term financing)
Line of Credits : Interest monthly(Common use is for short term financing and sometimes lenders require that a minimum amount, called a compensating balance be kept in the bank account.)
Term Loan Interest Calculation:First Step: Monthly Payment Calculation
Loan AmountMonthly Pmt = ________________________ 1
1- ________________ Interest Rate n OR EXCEL FUNCTION1 + ____________
12___________________ Interest Rate _____________ n= Number of months
12
Interest Calculation Methods S-T Financing
Business Loans
Term Loan Monthly Payment Calculation
Name of the Excel Function: PMT
Rate (Annual rate / # of payments in one year)Total # of payments for the loan (Nper)Loan Amount (PV)Future Value (FV)Type 1 if the payment is at the beginning of period
0 if the payment is at the end of period
Illustration:
Rate 5% / 12 = 0.00417Total # of payments 60 months ( 5 years)Loan Amount $10,000Future Value $0Type 0
Solution with Excel Function
=PMT(0.05/12,60,10000,0,0)
-$188.71 Monthly Payment
TERM LOAN PAYMENT CALCULATION BY USING EXCEL FUNCTION
Interest Calculation Methods S-T FinancingBusiness Loans
Second Step: $ Interest paid
$ Interest Paid = (Monthly Pmt X Number of Months) – (Loan Amount)
Third Step: % Interest Paid (Annual)
(Monthly Pmt X Number of Months) – (Loan Amount)Loan Amount_______________
Number of Years
Interest Calculation Methods S-T FinancingIllustration
Purchasing CNC Equipment of $10,000 with business term loan. 5%-interest & 5-year term (60 months)
First: Monthly Payment CalculationBy using the formula, monthly payment is calculated at $188.71 Second: Interest calculation$ Interest Paid ($188.71 X 60 months) – ($10,000) = $1,322.60
% Interest Paid (Annual) ($188.71 X 60 months) – ($10,000) = 2.64%
$10,000 ____________ 5 years
Interest Calculation Methods S-T Financing
Business Loans
Line of Credit Interest Calculation:Since some lenders require borrowers to keep a minimum amount in the bank account, called compensating balance, interest rate calculation
should take into consideration this balance. Formula for
the effective cost is shown as follows:
$ Interest Paid / (Loan Amount – Comp. Balance)
Example: Annual simple real cost for a line of credit of
$30,000 with simple interest of 5% and a $5,000
compensating balance is
$1,500* /($30,000-$5,000) = 6% (real cost)
* Assumed the line is fully utilized.
Interest Calculation Methods S-T Financing
Business Loans
Mechanism of Trade Credit
Typically receive a discount accounts payable early.
Stated as: 2/10, net 60 Purchaser receives a 2% discount if pay within 10 days of receiving invoice, otherwise due within 60 days.
The cost is in the form of the lost discount.
Mechanism of Trade Credit
Assume your purchase is $100 list.
If you take the discount, you pay $98.
If you don’t take the discount, you pay $100.
Therefore, you are paying $2 for the privilege of borrowing $98 for the additional 50 days.
(Note: the first 10 days are free in this example).
Interest Calculation Methods S-T FinancingTrade Credit
The exponent is the number of times per year the firm can take 50 days of credit. The cost of trade credit for 2/10 net 60 :[1 +(2/98)])7.2 -1 = 15.66%.
Day 0 Day 10 Day 60
360days to pay - disc. pd.
Cost =of Credit
Discount %1-Discount%( 1 + ) -1
$98 $98 + $2
Interest Calculation Methods S-T FinancingFactoring (Discount Loan)
Must pay the interest up front so that reduces the dollars available to use.Illustration: 9 % Discount $ 20 Flat Fee $10,000 x 9% x 90days + $20
360 days $ 225+ $20 = $ 245[$ 245/($10,000-$245)]*4 10.04 % ( Real Cost)
Case Analysis
Debt Service Coverage Analysis in S-T Financing
(Eligibility Criteria for business loans)
Lenders also calculates debt service coverage ratio before they give loan to businesses. Since each lender has different minimum requirements for this ratio, the calculation methods are identical. If the business cash flow is eligible under lender’s debt service coverage criteria, the lender usually grants the loan.
Debt Service Coverage Analysis in S-T Financing
(Example)
Statement Type Year Year 1Date 12/31/2003
BUSINESS:Net Profit $12,000Add:(+)Depreciation $1,500(+)Interest Expense $2,000Total (+) Adjustments $3,500
Cash Flow before Debt Service $15,500 (Net Profit + Total (+) Adjustments)Loan Annual Payment for Loan (6% interest payment) $6,000 ($100,000 X 6%)Total Debt Service $6,000
Net Cash Flow $9,500 (Cash Flow Before Debt Service - Total Debt Service) Business Debt Coverage Ratio 2.58 ( Cash Flow before Debt service / Total Debt Service)
Debt Service Coverage
Debt Service Coverage Analysis in S-T Financing
(Example)
If the lender requires minimum debt service coverage ratio of 1.2x from
the borrower, Neptune Inc. is eligible to
get the loan with a higher debt servicecoverage ratio, 2.58x.
Mini Case
CONGRATS !!!