short term financing alternatives

8/21/2019 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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11-2

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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11-3

Short-Term Financing Short-Term Financing

S.ontaneous Financing

6egotiated Financing Factoring &ccounts

7eceia"le

!om.osition of Short-TermFinancing


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11-4

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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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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)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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11-8

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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11-9

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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11-10

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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11-11


&..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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11-12

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


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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11-13

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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11-14

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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11-15

)ho "ears the Cost of)ho "ears the Cost of

Funds for Trade Credit* Funds for Trade Credit*


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11-16

Accrued +penses Accrued +penses

*ages*ages --


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11-17


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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11-19

"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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11-23


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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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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11-26

>10,000 in interest>100,000 in usa"le funds


Computing 7nterest 6atesComputing 7nterest 6ates

!ollect


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11-27

>10,000 in interest >D0,000 in usa"le funds


Computing 7nterest 6atesComputing 7nterest 6ates

)iscount


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11-28

>100,000 in interest >A0,000 in usa"le funds


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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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


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


+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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11-37

Types ofTypes of


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


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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11-39

Types ofTypes of


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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11-41

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'

&lthough 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$financing de.ends on$

short term financing alternatives

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