Download - Short Term Financing Alternatives
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11-1
Chapter 11Chapter 11
Short-TermShort-Term
FinancingFinancing
© Pearson Education Limited 2004Fundamentals of Financial Management, 12e
!reated "#$ %regor# &' (uhleme#er, Ph')'
!arroll !ollege, *au+esha, *
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After studying Chapter 11, After studying Chapter 11,
you should be able to:you should be able to:
nderstand the sources and t#.es of s.ontaneousfinancing'
!alculate the annual cost of trade credit /hen trade
discounts are forgone' E.lain /hat is meant "# stretching .a#a"les and
understand its .otential dra/"ac+s'
)escri"e arious t#.es of negotiated 3or eternalshort-term "orro/ing'
!alculate the effectie annual interest rate on short-term "orro/ing /ith or /ithout a com.ensating"alance re5uirement andor a commitment fee'
nderstand /hat is meant "# factoring accounts
receia"le'
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Short-Term Financing Short-Term Financing
S.ontaneous Financing
6egotiated Financing Factoring &ccounts
7eceia"le
!om.osition of Short-TermFinancing
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Spontaneous Financing Spontaneous Financing
&ccounts Pa#a"le3Trade !redit from Su..liers
&ccrued E.enses
T#.es of s.ontaneousT#.es of s.ontaneous
financingfinancing
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Spontaneous Financing Spontaneous Financing
Open Accounts$ the seller shi.s goods to the"u#er /ith an inoice s.ecif#ing goods
shi..ed, total amount due, and terms of thesale'
Notes ayable$ the "u#er signs a note thateidences a de"t to the seller'
Trade !reditTrade !redit -- credit granted from one"usiness to another'
Eam.les of trade credittrade credit are$
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Spontaneous Financing Spontaneous Financing
)raft)raft -- & signed, /ritten order "# /hich thefirst .art# 3dra/er instructs a second .art#3dra/ee to .a# a s.ecified amount of mone#to a third .art# 3.a#ee' The dra/er and.a#ee are often one and the same'
Trade Acceptances$ the seller dra/s a draft draft onthe "u#er that orders the "u#er to .a# the draft
at some future time .eriod'
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Terms of the SaleTerms of the Sale
Net eriod - No Cash !iscount Net eriod - No Cash !iscount
-- /hen credit is
etended, the seller s.ecifies the .eriod of timeallo/ed for .a#ment' 86et 90: im.lies full.a#ment in 90 da#s from the inoice date'
CO!CO! andand C"!C"! - No Trade Credit $ the "u#er.a#s cash on deli#erycash on deli#ery or cash before deli#ery cash before deli#ery '
This reduces the seller;s ris+ under CO!CO! to the"u#er refusing the shi.ment or eliminates itcom.letel# for !
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Terms of the SaleTerms of the Sale
Seasonal !ating Seasonal !ati ng -- credit terms that encourage the"u#er of seasonal .roducts to ta+e delier# "eforethe .ea+ sales .eriod and to defer .a#ment untilafter the .ea+ sales .eriod'
Net eriod - Cash !iscount Net eriod - Cash !iscount -- /hen credit isetended, the seller s.ecifies the .eriod of timeallo/ed for .a#ment and offers a cash discount if
.aid in the earl# .art of the .eriod' 8210, net 90:im.lies full .a#ment /ithin 90 da#s from the inoicedate less a 2= discount if .aid /ithin 10 da#s'
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Trade Credit as aTrade Credit as a
$eans of Financing $eans of Financing
>1,000 90 da#s ? >90,000 account "alance
*hat ha..ens to accounts .a#a"le if a*hat ha..ens to accounts .a#a"le if a
firm .urchases >1,000da# at 8net 90:@firm .urchases >1,000da# at 8net 90:@
*hat ha..ens to accounts .a#a"le if a*hat ha..ens to accounts .a#a"le if a
firm .urchases >1,A00da# at 8net 90:@firm .urchases >1,A00da# at 8net 90:@>1,A00 90 da#s ? >4A,000 account "alance
A %1&,''' increase from operations A %1& ,''' increase from operations( (
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Cost to Forgo a !iscount Cost to Forgo a !iscount
&..roimate annual interest cost ?
= discount 9BA da#s
3100= - = discount 3.a#ment date -discount .eriod
*hat is the a..roimate annual cost*hat is the a..roimate annual cost
to forgo the cash discount of 8210,to forgo the cash discount of 8210,
net 90: after the first ten da#s@net 90: after the first ten da#s@
C
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Cost to Forgo a !iscount Cost to Forgo a !iscount
&..roimate annual interest cost ?
2= 9BA da#s
3100= - 2= 390 da#s - 10 da#s
? 32D 39BA20 ? 9'2=
*hat is the a..roimate annual cost to*hat is the a..roimate annual cost to
forgo the cash discount of 8210, net 90,:forgo the cash discount of 8210, net 90,:
and .a# at the end of the credit .eriod@and .a# at the end of the credit .eriod@
C
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Pa#ment )ateGPa#ment )ateG &nnual rate of interest&nnual rate of interest
11 44'D=
20 4'A 9090 9'29'2 B0 14'D D0 D'9G da#s from inoice date
Cost to Forgo a !iscount Cost to Forgo a !iscount
The a..roimate interest cost oer aThe a..roimate interest cost oer a
ariet# of .a#ment decisions forariet# of .a#ment decisions for
88210, net HHHH 210, net HHHH ':':
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S-t-r-e-t-c-h-i-n-gS-t-r-e-t-c-h-i-n-g
Account ayables Account ayables
!ost of the cash discount 3if an# forgone
Late .a#ment .enalties or interest
)eterioration in credit rating
Post.oning .a#ment "e#ond the end of thePost.oning .a#ment "e#ond the end of the
net 3credit .eriod is +no/n asnet 3credit .eriod is +no/n as 8stretching8stretching
accounts .a#a"le:accounts .a#a"le: or 8leaning on the trade':or 8leaning on the trade':Possi"le costsPossi"le costs ofof 8stretching8stretching
accounts .a#a"le:accounts .a#a"le:
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Ad#antages of Ad#antages of
Trade Credit Trade Credit
!onenience and aaila"ilit# of
trade credit %reater flei"ilit# as a means of
financing
!om.are costs of forgoing a .ossi"le!om.are costs of forgoing a .ossi"le
cash discount against the adantagescash discount against the adantages
of trade credit'of trade credit'
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)ho "ears the Cost of)ho "ears the Cost of
Funds for Trade Credit* Funds for Trade Credit*
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Accrued +penses Accrued +penses
*ages*ages --
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Spontaneous Financing Spontaneous Financing
Mone# Mar+et !reditMone# Mar+et !redit !ommercial Pa.er
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Stand-Alone.Stand-Alone.
Commercial aper Commercial aper
!ommercial .a.er mar+et is com.osed of the!ommercial .a.er mar+et is com.osed of the31 dealer and 32 direct-.lacement mar+ets'
&dantage&dantage$ !hea.er than a short-term
"usiness loan from a commercial "an+' )ealers re5uire a line of creditline of credit to ensure that
the commercial .a.er is .aid off'
Commercial aper Commercial aper -- Short-term, unsecured.romissor# notes, generall# issued "# largecor.orations 3unsecured cor.orate Is'
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"an/-Supported."an/-Supported.
Commercial aper Commercial aper
Letter of credit 3L!Letter of credit 3L! -- & .romise from athird .art# 3usuall# a "an+ for .a#mentin the eent that certain conditions are
met' t is fre5uentl# used to guarantee.a#ment of an o"ligation'
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"an/ers0 Acceptances"an/ers0 Acceptances
sed to facilitate foreign trade or theshi.ment of certain mar+eta"le goods'
Li5uid mar+et .roides rates similar tocommercial .a.er rates'
"an/ers0 Acceptances"an/ers0 Acceptances -- Short-term.romissor# trade notes for /hich a "an+ 3"#haing 8acce.ted: them .romises to .a#
the holder the face amount at maturit#'
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Short-TermShort-Term
"usiness oans"usiness oans
Secured oansSecured oans -- & form of de"t for
mone# "orro/ed in /hich s.ecificassets hae "een .ledged to guarantee.a#ment'
2nsecured oans2nsecured oans -- & form of de"t formone# "orro/ed that is not "ac+ed "#
the .ledge of s.ecific assets'
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2nsecured oans2nsecured oans
Ine-#ear limit that is reie/ed .rior to rene/al todetermine if conditions necessitate a change'
!redit line is "ased on the "an+;s assessment ofthe credit/orthiness and credit needs of the firm'
8!leanu.: .roision re5uires the firm to o/e the
"an+ nothing for a .eriod of time'
ine of Credit 34ith a ban/5ine of Credit 34ith a ban/5 -- &n informalarrangement "et/een a "an+ and itscustomer s.ecif#ing the maimum amount of
credit the "an+ /ill .ermit the firm to o/e atan# one time'
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2nsecured oans2nsecured oans
Firm receies reoling credit "# .a#ing a
commitment feecommitment fee on an# unused .ortion of themaimum amount of credit'
!ommitment fee!ommitment fee -- & fee charged "# the lender foragreeing to hold credit aaila"le'
&greements fre5uentl# etend "e#ond 1 #ear'
6e#ol#ing Credit Agreement 6e#ol#ing Credit Agreement -- & formal, legalcommitment to etend credit u. to some
maimum amount oer a stated .eriod of time'
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2nsecured oans2nsecured oans
Each re5uest is handled as a se.aratetransaction "# the "an+, and .roJect loandetermination is "ased on the cash-flo/ a"ilit#
of the "orro/er'
The loan is .aid off at the com.letion of the.roJect "# the firm from resulting cash flo/s'
Transaction oanTransaction oan -- & loan agreementthat meets the short-term funds needs of
the firm for a single, s.ecific .ur.ose'
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!etour:!etour: Cost of "orro4ing Cost of "orro4ing
)ifferential from .rime de.ends on$
!ash "alances Ither "usiness /ith the "an+
!ost of sericing the loan
7nterest 6ates7nterest 6ates
Prime 7ate -- Short-term interest rate charged"# "an+s to large, credit/orth# customers'
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>10,000 in interest>100,000 in usa"le funds
!etour:!etour: Cost of "orro4ing Cost of "orro4ing
Computing 7nterest 6atesComputing 7nterest 6ates
!ollect
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>10,000 in interest >D0,000 in usa"le funds
!etour:!etour: Cost of "orro4ing Cost of "orro4ing
Computing 7nterest 6atesComputing 7nterest 6ates
)iscount
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>100,000 in interest >A0,000 in usa"le funds
!etour:!etour: Cost of "orro4ing Cost of "orro4ing
Compensating "alancesCom pensating "alances
)emand de.osits maintained "# a firm to
com.ensate a "an+ for serices .roided, creditlines, or loans'
Eam.le$ >1,000,000 loan at 10= stated interest rate for 1 #ear /ith a re5uired >1A0,000 com.ensating "alance'
? 11'B=
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!etour:!etour: Cost of "orro4ing Cost of "orro4ing
Commitment FeesCommitment Fees
The fee charged "# the lender for agreeing to hold
credit aaila"le is on the unused .ortions of credit'
Eam.le$ >1 million reoling credit at 10= statedinterest rate for 1 #earK "orro/ing for the #ear /as>B00,000K a re5uired A= com.ensating "alance on
"orro/ed fundsK and a 'A= commitment fee on>400,000 of unused credit'
*hat is the cost of "orro/ing@*hat is the cost of "orro/ing@
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>B0,000 in interest >2,000 in commitment fees
>A0,000 in usa"le funds
!etour:!etour: Cost of "orro4ing Cost of "orro4ing
nterest$ 3>B00,000 310= ? > B0,000
!ommitmentFee$ 3>400,000 30'A= ? > 2,000
!om.ensatingB00,000 3A= ? > 90,000
sa"le Funds$ >B00,000 - >90,000 ? >A0,000
? 10'=
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&ssume the same loan descri"ed on slide 11-2D ece.t that the loanis for 20 da#s and the 10= rate is on an annual "asis' *hat isthe E&7@
>44,94 in interest, >2,000 in commitment fees, and >A0,000 in
usa"le funds'
>44,94 >2,000 9BA>A0,000 20
!etour:!etour: Cost of "orro4ing Cost of "orro4ing
+ffecti#e Annual 6ate of nterest 3generall# ?
Total interest .aid total fees .aid 9BA da#s '
sa"le funds of da#s loan is outstanding
? '19= 1'9A1D ? 11'00=11'00=
CC
CC
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SecuredSecured
3or Asset-"ased5 oans3or Asset-"ased5 oans
Mar+eta"ilit# Life
7is+iness
Securit# 3collateralSecurit# 3collateral -- &sset 3s .ledged "#a "orro/er to ensure re.a#ment of a loan'f the "orro/er defaults, the lender ma#sell the securit# to .a# off the loan'
!ollateral alue de.ends on!ollateral alue de.ends on$
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2niform Commercial Code2niform Commercial Code
Securit# interests of the lender
Securit# agreement 3deice
Filing of the securit# agreement
Model state legislation related to man#as.ects of commercial transactions that/ent into effect in Penns#lania in 1DA4' thas "een ado.ted /ith limited changes "#most state legislatures'
&rticle D of the !ode deals /ith&rticle D of the !ode deals /ith$
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Accounts-6ecei#able- Accounts-6ecei#able-
"ac/ed oans"ac/ed oans
Nualit#$ not all indiidual accounts hae to
"e acce.ted 3ma# reJect on aging aging ' SiOe$ small accounts ma# "e reJected as
"eing too costl# 3.er dollar of loan tohandle "# the institution'
Ine of the most li5uid asset accounts'
Loans "# commercial "an+s or finance
com.anies 3"an+s offer lo/er interest rates'Loan ealuations are made onLoan ealuations are made on$
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Accounts-6ecei#able- Accounts-6ecei#able-
"ac/ed oans"ac/ed oans
6otification6otification -- firm customers are notifiedthat their accounts hae "een .ledged to thelender and remittances are made directl# tothe lending institution'
T#.es of receia"le loan arrangementsT#.es of receia"le loan arrangements$
6onnotification6onnotification -- firm customers are not
notified that their accounts hae "een.ledged to the lender' The firm for/ards all.a#ments from .ledged accounts to thelender'
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7n#entory-"ac/ed oans7n#entory-"ac/ed oans
Mar+eta"ilit# Perisha"ilit#
Price sta"ilit#
)ifficult# and e.ense of selling for loansatisfaction
!ash-flo/ a"ilit#
7elatiel# li5uid asset accounts
Loan ealuations are made onLoan ealuations are made on$
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Types ofTypes of
7n#entory-"ac/ed oans7n#entory-"ac/ed oans
Floating LienFloating Lien -- & general, or "lan+et,lien against a grou. of assets, such as
inentor# or receia"les, /ithout theassets "eing s.ecificall# identified'
!hattel Mortgage!hattel Mortgage -- & lien on
s.ecificall# identified personal property 3assets other than real estate"ac+ing a loan'
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Types ofTypes of
7n#entory-"ac/ed oans7n#entory-"ac/ed oans
Trust 7ecei.tTrust 7ecei.t -- & securit# deiceac+no/ledging that the "orro/er holds
s.ecificall# identified inentor# and.roceeds from its sale in trust for thelender'
Terminal *arehouse 7ecei.tTerminal *arehouse 7ecei.t -- &
recei.t for the de.osit of goods in a.u"lic /arehouse that a lender holdsas collateral for a loan'
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Types ofTypes of
7n#entory-"ac/ed oans7n#entory-"ac/ed oans
Field *arehouse 7ecei.tField *arehouse 7ecei.t -- &recei.t for goods segregated andstored on the "orro/er;s .remises3"ut under the control of aninde.endent /arehousingcom.an# that a lender holds ascollateral for a loan'
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FactoringFactoring
Accounts 6ecei#able Accounts 6ecei#able
Factor Factor is often a su"sidiar# of a "an+ holdingcom.an#'
Factor Factor maintains a credit de.artment and .erformscredit chec+s on accounts'
&llo/s firm to eliminate their credit de.artmentand the associated costs'
!ontracts are usuall# for 1 #ear, "ut are rene/a"le'
FactoringFactoring -- The selling of receia"les to afinancial institution, the factor factor , usuall#8/ithout recourse':
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FactoringFactoring
Accounts 6ecei#able Accounts 6ecei#able
Factor receies a commission on the face alue ofthe receia"les 3t#.icall# 1= "ut as much as 9='
!ash .a#ment is usuall# made on the actual oraerage due date of the receia"les'
f the factor adances mone# to the firm, then thefirm must .a# interest on the adance'
Total cost of factoring is com.osed of a factoringfee .lus an interest charge on an# cash adance'
<hough e.ensie, it .roides the firm /ithsu"stantial flei"ilit#'
Factoring !ostsFactoring !osts
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Composition ofComposition of
Short-Term Financing Short-Term Financing
!ost of the financing method &aila"ilit# of funds
Timing
Flei"ilit#
)egree to /hich the assets areencum"ered
The "est mi of short-termThe "est mi of short-term
financing de.ends on$financing de.ends on$