1 © copyright doug hillman 1999 short-term financing
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1© Copyright Doug Hillman 1999
Short-Term Financing
2© Copyright Doug Hillman 1999
Financing Considerations
Interest cost Continuing availability of financing
method Effects on availability and cost of
alternative sources of money
3© Copyright Doug Hillman 1999
Promissory Note
Unconditional written promise to pay
4© Copyright Doug Hillman 1999
Promissory Note
Unconditional written promise to pay a definite sum of money
5© Copyright Doug Hillman 1999
Promissory Note
Unconditional written promise to pay a definite sum of money on demand or at a future date.
6© Copyright Doug Hillman 1999
Promissory Note
Unconditional written promise to pay a definite sum of money on demand or at a future date.
Person promising to payee is maker Person promised the payment is payee
7© Copyright Doug Hillman 1999
Characteristics of Promissory Note
In writing and signed by maker Unconditional promise to pay a certain
sum of money Payable to a bearer or stated person Payable on demand or a specified future
time May or may not be interest bearing
8© Copyright Doug Hillman 1999
Maturity Date
Date when payment is due Calculation
› Days in month note is dated minus date of note
› Add number of days in succeeding months until total is reached
9© Copyright Doug Hillman 1999
Computing Interest
Interest = Principal x Rate x Time Maturity stated in days $30 = $1,000 x 0.12 x 90/360 Maturity stated in months $50 = $1,000 x 0.12 x 5/12 Maturity stated in years $240 = $1,000 x 0.12 x 2
10© Copyright Doug Hillman 1999
Maturity Value of Note
Principal amount plus interest to maturity
$1,000, 12%, 90 day note $1,000 + $30 = $1,030
11© Copyright Doug Hillman 1999
Annual Effective Interest Rate
Average annual interest cost divided by Average outstanding principal Borrow $1,000 with 24 payments of $50 24 x $50 = $1,200 $1,200 - $1,000 = $200 $100 / $500 = 20%
12© Copyright Doug Hillman 1999
Issuance of Note Bearing Interest on Face Value
At issuance› Increase Cash for amount received (face value)› Increase Notes Payable for face value
At maturity› Decrease Notes Payable for face value› Increase Interest Expense for interest to
maturity› Decrease Cash for total
13© Copyright Doug Hillman 1999
Issuance of Note Discounted on Face Value
At issuance› Increase Cash for face value less discount› Increase Discount on Notes Payable for
discount› Increase Notes Payable for face value
14© Copyright Doug Hillman 1999
Issuance of Note Discounted on Face Value
At maturity› Increase Interest Expense for discount› Decrease Discount on Notes Payable for
discount› Decrease Notes Payable for face value› Decrease Cash for face value
15© Copyright Doug Hillman 1999
Effective Interest Calculation
EffectiveInterest
Rate
Discount
Net Proceeds
360
Termof Note
= X
16© Copyright Doug Hillman 1999
End of Period Adjustments
Notes written in one accounting period and maturing in a later period require adjustment to accrue interest
Calculate interest from date of note to period ending date
17© Copyright Doug Hillman 1999
Notes Receivable
Receipt of note for sale› Record normal sale entry› Transfer amount from Accounts Receivable
to Notes Receivable Receipt of note in settlement of open
account› Transfer amount from Accounts Receivable
to Notes Receivable
18© Copyright Doug Hillman 1999
Discounting Customers Note
Determine maturity value Find discount period bank will hold note Compute discount by multiplying
maturity value by discount rate Deduct discount from maturity value to
determine proceeds
19© Copyright Doug Hillman 1999
Discounting Customers Note
Payee is contingently liable for note if maker does not pay at maturity
Notes Receivable Discounted used to indicate contingent liability
Presentation
Notes Receivable $1,000
Deduct: N/R discounted 400
Net Notes Receivable $600
20© Copyright Doug Hillman 1999
Analyzing Information Determine the availability and adequacy of
credit sources What percent of credit line used up at balance
sheet date? When does the line expire? Is it likely to be renewed? Are any credit line requirements not being met? Is credit line sufficient?