1-2Short-Term FinancingShort-Term FinancingSpontaneous FinancingNegotiated FinancingFactoring AccountsReceivableComposition of Short-TermFinancing
1-3Spontaneous FinancingSpontaneous FinancingAccounts Payable(Trade Credit from Suppliers)Accrued ExpensesTypes of spontaneousTypes of spontaneousfinancingfinancing
1-4Spontaneous FinancingSpontaneous FinancingOpen Accounts: the seller ships goods to thebuyer with an invoice specifying goodsshipped, total amount due, and terms of thesale.Notes Payable: the buyer signs a note thatevidences a debt to the seller.Trade CreditTrade Credit -- credit granted from onebusiness to another.Examples of trade credittrade credit are:
1-5Spontaneous FinancingSpontaneous FinancingDraftDraft -- A signed, written order by which thefirst party (drawer) instructs a second party(drawee) to pay a specified amount of moneyto a third party (payee). The drawer andpayee are often one and the same.Trade Acceptances: the seller draws a draftdraft onthe buyer that orders the buyer to pay the draftat some future time period.
1-6Terms of the SaleTerms of the SaleNet Period - No Cash DiscountNet Period - No Cash Discount -- when credit isextended, the seller specifies the period of timeallowed for payment. “Net 30” implies fullpayment in 30 days from the invoice date.CODCOD andand CBDCBD - No Trade Credit: the buyerpays cash on deliverycash on delivery or cash before deliverycash before delivery.This reduces the seller’s risk under CODCOD to thebuyer refusing the shipment or eliminates itcompletely for CBD.
1-7Terms of the SaleTerms of the SaleSeasonal DatingSeasonal Dating -- credit terms that encourage thebuyer of seasonal products to take delivery beforethe peak sales period and to defer payment untilafter the peak sales period.Net Period - Cash DiscountNet Period - Cash Discount -- when credit isextended, the seller specifies the period of timeallowed for payment and offers a cash discount ifpaid in the early part of the period. “2/10, net 30”implies full payment within 30 days from the invoicedate less a 2% discount if paid within 10 days.
1-8Trade Credit as aTrade Credit as aMeans of FinancingMeans of Financing$1,000 x 30 days = $30,000 account balanceWhat happens to accounts payable if aWhat happens to accounts payable if afirm purchases $1,000/day at “net 30”?firm purchases $1,000/day at “net 30”?What happens to accounts payable if aWhat happens to accounts payable if afirm purchases $1,500/day at “net 30”?firm purchases $1,500/day at “net 30”?$1,500 x 30 days = $45,000 account balanceA $15,000 increase from operationsA $15,000 increase from operations!!
1-9Cost to Forgo a DiscountCost to Forgo a DiscountApproximate annual interest cost =% discount 365 days(100% - % discount) (payment date -discount period)What is the approximate annual costWhat is the approximate annual costto forgo the cash discount of “2/10,to forgo the cash discount of “2/10,net 30” after the first ten days?net 30” after the first ten days?X
1-10Cost to Forgo a DiscountCost to Forgo a DiscountApproximate annual interest cost =2% 365 days(100% - 2%) (30 days - 10 days)= (2/98) x (365/20) = 37.2%What is the approximate annual cost toWhat is the approximate annual cost toforgo the cash discount of “2/10, net 30,”forgo the cash discount of “2/10, net 30,”and pay at the end of the credit period?and pay at the end of the credit period?X
1-11Payment Date*Payment Date* Annual rate of interestAnnual rate of interest11 744.9%20 74.53030 37.237.260 14.990 9.3* days from invoice dateCost to Forgo a DiscountCost to Forgo a DiscountThe approximate interest cost over aThe approximate interest cost over avariety of payment decisions forvariety of payment decisions for““2/10, net ____2/10, net ____.”.”
1-12S-t-r-e-t-c-h-i-n-gS-t-r-e-t-c-h-i-n-gAccount PayablesAccount PayablesCost of the cash discount (if any) forgoneLate payment penalties or interestDeterioration in credit ratingPostponing payment beyond the end of thePostponing payment beyond the end of thenet period is known asnet period is known as “stretching accounts“stretching accountspayable”payable” or “leaning on the trade.”or “leaning on the trade.”Possible costsPossible costs ofof “stretching“stretchingaccounts payable”accounts payable”
1-13Advantages ofAdvantages ofTrade CreditTrade CreditConvenience and availability oftrade creditGreater flexibility as a means offinancingCompare costs of forgoing a possibleCompare costs of forgoing a possiblecash discount against the advantagescash discount against the advantagesof trade credit.of trade credit.
1-14Who Bears the Cost ofWho Bears the Cost ofFunds for Trade Credit?Funds for Trade Credit?BuyersBuyers -- when costs can be fullypassed on through higher prices to thebuyer by the seller.BothBoth -- when costs can partially bepassed on to buyers by sellers.SuppliersSuppliers -- when trade costs cannotbe passed on to buyers because ofprice competition and demand.
1-15Accrued ExpensesAccrued ExpensesWagesWages -- Benefits accrue via no directcash costs, but costs can develop byreduced employee morale and efficiency.TaxesTaxes -- Benefits accrue until the duedate, but costs of penalties and interestbeyond the due date reduce the benefits.Accrued ExpensesAccrued Expenses -- Amounts owed but not yetpaid for wages, taxes, interest, and dividends.The accrued expenses account is a short-termliability.
1-16Spontaneous FinancingSpontaneous FinancingMoney Market CreditMoney Market CreditCommercial PaperBankers’ AcceptancesUnsecured LoansUnsecured LoansLine of CreditRevolving Credit AgreementTransaction LoanTypes of negotiated financingTypes of negotiated financing:
1-17““Stand-Alone”Stand-Alone”Commercial PaperCommercial PaperCommercial paper market is composed ofCommercial paper market is composed ofthethe (1) dealer and (2) direct-placementmarkets.AdvantageAdvantage: Cheaper than a short-termbusiness loan from a commercial bank.Dealers require a line of creditline of credit to ensure thatthe commercial paper is paid off.Commercial PaperCommercial Paper -- Short-term, unsecuredpromissory notes, generally issued by largecorporations (unsecured corporate IOUs).
1-18““Bank-Supported”Bank-Supported”Commercial PaperCommercial PaperLetter of credit (L/C)Letter of credit (L/C) -- A promise from athird party (usually a bank) for paymentin the event that certain conditions aremet. It is frequently used to guaranteepayment of an obligation.Best for lesser-known firms to accesslower cost funds.A bank provides a letter of creditletter of credit, for a fee,guaranteeingguaranteeing the investor that the company’sobligation will be paid.
1-19Bankers’ AcceptancesBankers’ AcceptancesUsed to facilitate foreign trade or theshipment of certain marketable goods.Liquid market provides rates similar tocommercial paper rates.Bankers’ AcceptancesBankers’ Acceptances -- Short-termpromissory trade notes for which a bank (byhaving “accepted” them) promises to paythe holder the face amount at maturity.
1-20Short-TermShort-TermBusiness LoansBusiness LoansSecured LoansSecured Loans -- A form of debt formoney borrowed in which specificassets have been pledged to guaranteepayment.Unsecured LoansUnsecured Loans -- A form of debt formoney borrowed that is not backed bythe pledge of specific assets.
1-21Unsecured LoansUnsecured LoansOne-year limit that is reviewed prior to renewal todetermine if conditions necessitate a change.Credit line is based on the bank’s assessment ofthe creditworthiness and credit needs of the firm.“Cleanup” provision requires the firm to owe thebank nothing for a period of time.Line of Credit (with a bank)Line of Credit (with a bank) -- An informalarrangement between a bank and itscustomer specifying the maximum amount ofunsecured credit the bank will permit the firmto owe at any one time.
1-22Unsecured LoansUnsecured LoansFirm receives revolving credit by paying acommitment feecommitment fee on any unused portion of themaximum amount of credit.Commitment feeCommitment fee -- A fee charged by the lender foragreeing to hold credit available.Agreements frequently extend beyond 1 year.Revolving Credit AgreementRevolving Credit Agreement -- A formal, legalcommitment to extend credit up to somemaximum amount over a stated period of time.
1-23Unsecured LoansUnsecured LoansEach request is handled as a separatetransaction by the bank, and project loandetermination is based on the cash-flow abilityof the borrower.The loan is paid off at the completion of theproject by the firm from resulting cash flows.Transaction LoanTransaction Loan -- A loan agreementthat meets the short-term funds needs ofthe firm for a single, specific purpose.
1-24Detour:Detour: Cost of BorrowingCost of BorrowingDifferential from prime depends on:Cash balancesOther business with the bankCost of servicing the loanInterest RatesInterest RatesPrime Rate -- Short-term interest rate chargedby banks to large, creditworthy customers.
1-25$10,000 in interest$100,000 in usable fundsDetour:Detour: Cost of BorrowingCost of BorrowingComputing Interest RatesComputing Interest RatesCollect BasisCollect Basis -- interest is paid at maturity ofthe note.Example: $100,000 loan at 10%stated interest rate for 1 year.= 10.00%
1-26$10,000 in interest$90,000 in usable fundsDetour:Detour: Cost of BorrowingCost of BorrowingComputing Interest RatesComputing Interest RatesDiscount BasisDiscount Basis -- interest is deducted fromthe initial loan.Example: $100,000 loan at 10%stated interest rate for 1 year.= 11.11%
1-27$100,000 in interest$850,000 in usable fundsDetour:Detour: Cost of BorrowingCost of BorrowingCompensating BalancesCompensating BalancesNon-interest-bearing demand deposits maintained bya firm to compensate a bank for services provided,credit lines, or loans.Example: $1,000,000 loan at 10% stated interest rate for1 year with a required $150,000 compensating balance.= 11.76%
1-28Detour:Detour: Cost of BorrowingCost of BorrowingCommitment FeesCommitment FeesThe fee charged by the lender for agreeing to holdcredit available is on the unused portions of credit.Example: $1 million revolving credit at 10% statedinterest rate for 1 year; borrowing for the year was$600,000; a required 5% compensating balance onborrowed funds; and a .5% commitment fee on$400,000 of unused credit.What is the cost of borrowing?What is the cost of borrowing?
1-29$60,000 in interest +$2,000 in commitment fees$570,000 in usable fundsDetour:Detour: Cost of BorrowingCost of BorrowingInterest: ($600,000) x (10%) = $ 60,000CommitmentFee: ($400,000) x (0.5%) = $ 2,000CompensatingBalance: ($600,000) x (5%) = $ 30,000Usable Funds: $600,000 - $30,000 = $570,000= 10.88%
1-30SecuredSecured(or Asset-Based) Loans(or Asset-Based) LoansMarketabilityLifeRiskinessSecurity (collateral)Security (collateral) -- Asset (s) pledged bya borrower to ensure repayment of a loan.If the borrower defaults, the lender maysell the security to pay off the loan.Collateral value depends onCollateral value depends on:
1-31Uniform Commercial CodeUniform Commercial CodeSecurity interests of the lenderSecurity agreement (device)Filing of the security agreementModel state legislation related to manyaspects of commercial transactions thatwent into effect in Pennsylvania in 1954. Ithas been adopted with limited changes bymost state legislatures.Article 9 of the Code deals withArticle 9 of the Code deals with:
1-32Accounts-Receivable-Accounts-Receivable-Backed LoansBacked LoansQuality: not all individual accounts have tobe accepted (may reject on agingaging).Size: small accounts may be rejected asbeing too costly (per dollar of loan) tohandle by the institution.One of the most liquid asset accounts.Loans by commercial banks or financecompanies (banks offer lower interest rates).Loan evaluations are made onLoan evaluations are made on:
1-33Accounts-Receivable-Accounts-Receivable-Backed LoansBacked LoansNotificationNotification -- firm customers are notifiedthat their accounts have been pledged to thelender and remittances are made directly tothe lending institution.Types of receivable loan arrangementsTypes of receivable loan arrangements:NonnotificationNonnotification -- firm customers are notnotified that their accounts have beenpledged to the lender. The firm forwards allpayments from pledged accounts to thelender.
1-34Inventory-Backed LoansInventory-Backed LoansMarketabilityPerishabilityPrice stabilityDifficulty and expense of selling for loansatisfactionCash-flow abilityRelatively liquid asset accountsLoan evaluations are made onLoan evaluations are made on:
1-35Types ofTypes ofInventory-Backed LoansInventory-Backed LoansFloating LienFloating Lien -- A general, or blanket,lien against a group of assets, such asinventory or receivables, without theassets being specifically identified.Chattel MortgageChattel Mortgage -- A lien onspecifically identified personalproperty (assets other than real estate)backing a loan.
1-36Types ofTypes ofInventory-Backed LoansInventory-Backed LoansTrust ReceiptTrust Receipt -- A security deviceacknowledging that the borrower holdsspecifically identified inventory andproceeds from its sale in trust for thelender.Terminal Warehouse ReceiptTerminal Warehouse Receipt -- Areceipt for the deposit of goods in apublic warehouse that a lender holdsas collateral for a loan.
1-37Types ofTypes ofInventory-Backed LoansInventory-Backed LoansField Warehouse ReceiptField Warehouse Receipt -- Areceipt for goods segregated andstored on the borrower’s premises(but under the control of anindependent warehousingcompany) that a lender holds ascollateral for a loan.
1-38FactoringFactoringAccounts ReceivableAccounts ReceivableFactorFactor is often a subsidiary of a bank holdingcompany.FactorFactor maintains a credit department and performscredit checks on accounts.Allows firm to eliminate their credit departmentand the associated costs.Contracts are usually for 1 year, but are renewable.FactoringFactoring -- The selling of receivables to afinancial institution, the factorfactor, usually“without recourse.”
1-39FactoringFactoringAccounts ReceivableAccounts ReceivableFactor receives a commission on the face value ofthe receivables.Cash payment is usually made on the actual oraverage due date of the receivables.If the factor advances money to the firm, then thefirm must pay interest on the advance.Total cost of factoring is composed of a factoringfee plus an interest charge on any cash advance.Although expensive, it provides the firm withsubstantial flexibility.Factoring CostsFactoring Costs
1-40Composition ofComposition ofShort-Term FinancingShort-Term FinancingCost of the financing methodAvailability of fundsTimingFlexibilityDegree to which the assets areencumberedThe best mix of short-termThe best mix of short-termfinancing depends on:financing depends on: