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Short TermShort Term
FinancingFinancing
2
Learning ObjectivesLearning Objectives
The need for short-term financing.
The advantages and disadvantages of
short-te...
3
Why Do Firms NeedWhy Do Firms Need
Short-term Financing?Short-term Financing?
Cash flow from operations may not be suff...
4
Sources of Short-termSources of Short-term
FinancingFinancing
Short-term Loans.
• borrowing from banks and other financ...
5
Types of short-termTypes of short-term
loans:loans:Promissory Note
• A legal IOU that spells out the terms of the
loan ...
6
Types of short-termTypes of short-term
loans:loans:Line of Credit
• The borrowing limit that a bank sets for a firm
aft...
7
Trade CreditTrade Credit
Trade credit is the act of obtaining funds by delaying
payment to suppliers, who typically gra...
8
Estimation of Cost of Short-TermEstimation of Cost of Short-Term
CreditCredit
Calculation is easiest if the loan is for...
9
Variations in Loan TermsVariations in Loan Terms
A discount loan requires that interest be paid up
front when the loan ...
10
Variations in LoanVariations in Loan
TermsTermsSometimes lenders require that a minimum
amount, called a compensating ...
11
Both Discount InterestBoth Discount Interest
and Compensating Balanceand Compensating Balance
Sometimes, lenders will ...
12
Cost of Short TermCost of Short Term
CreditCreditCost of Trade Credit
• Typically receive a discount if you pay early....
13
Calculating APRCalculating APR (same as(same as
EIR)EIR)
$ Interest = Rate x Principle x Time
i.e. Int = 6% x $1,000 ...
14
Cost of Trade Credit 2/10 netCost of Trade Credit 2/10 net
6060
Assume your purchase is $100 list price.
If you take ...
15
Commercial PaperCommercial Paper
Commercial paper is quoted on a discount basis,
meaning that the interest is subtract...
16
Cost of Commercial PaperCost of Commercial Paper
ExampleExample$1 million issue of 90 day commercial paper quoted at 4...
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Accounts Receivable asAccounts Receivable as
CollateralCollateralA pledge is a promise that the borrowing firm will pa...
18
Cost of Borrowing against ReceivablCost of Borrowing against Receivabl
Average monthly sales = $100,000
60 day terms,...
19
Inventory as CollateralInventory as Collateral
A major problem with inventory financing is valuing the
inventory.
For...
20
DIFFERENT FINANCINGDIFFERENT FINANCING
OPTIONSOPTIONS
21
QUESTIONS TO ASK WHENQUESTIONS TO ASK WHEN
LOOKING FOR FINANCINGLOOKING FOR FINANCING
WHAT AMOUNT DO I NEED?
HOW DO I ...
22
QUESTIONS LENDERS WILLQUESTIONS LENDERS WILL
ASK BEFORE TAKINGASK BEFORE TAKING
DECISIONDECISION
INFORMATION TO DERTER...
23
FINANCING METHODSFINANCING METHODS
SHORT TERM FINANCING
LONG TERM FINANCING
24
SHORT TERM LOANSSHORT TERM LOANS
Use for seasonal build-ups of inventory
and receivables, as well as to take
advantage ...
25
CREDIT LINESCREDIT LINES
The lender, usually a bank, supplies a business with
funds intended to fill temporary shortage...
26
ASSET - BASEDASSET - BASED
FINANCINGFINANCINGA lender accepts as collateral the
assets of a company in exchange for a
l...
27
FACTORINGFACTORING
Similar to accounts receivable financing with one
notable exception.
 Factors actually buy your rec...
28
TERM LOANSTERM LOANS
Use to finance your permanent working capital,
purchase of new equipment, construction of
building...
29
LEASINGLEASING
This has become a significant source of
intermediate-term financing for small companies
in recent years....
30
VENTURE CAPITALVENTURE CAPITAL
One problem many new businesses face is raising
sufficient capital.
A business in its p...
31
LETTER OF CREDITLETTER OF CREDIT
A letter of credit is a guarantee from a
bank that a specific obligation will be
honor...
32
ANGEL INVESTINGANGEL INVESTING
Angel investor or Business angel is an
affluent individual who provides capital
for a s...
33
PRIVATE EQUITY
FUNDS
A fund that invests in companies and/or entire
business units with the intention of obtaining
a co...
34
THANK YOU
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Short term finance

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Short term financing

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Short term finance

  1. 1. 1 Short TermShort Term FinancingFinancing
  2. 2. 2 Learning ObjectivesLearning Objectives The need for short-term financing. The advantages and disadvantages of short-term financing. Types of short-term financing. Computation of the cost of trade credit, commercial paper, and bank loans. How to use accounts receivable and inventory as collateral for short-term loans.
  3. 3. 3 Why Do Firms NeedWhy Do Firms Need Short-term Financing?Short-term Financing? Cash flow from operations may not be sufficient to keep up with growth-related financing needs. Firms may prefer to borrow now for their inventory or other short term asset needs rather than wait until they have saved enough. Firms prefer short-term financing instead of long- term sources of financing due to: • easier availability • usually has lower cost (remember yield curve) • matches need for short term assets, like inventory
  4. 4. 4 Sources of Short-termSources of Short-term FinancingFinancing Short-term Loans. • borrowing from banks and other financial institutions for one year or less. Trade Credit. • borrowing from suppliers Commercial Paper. • only available to large credit- worthy businesses.
  5. 5. 5 Types of short-termTypes of short-term loans:loans:Promissory Note • A legal IOU that spells out the terms of the loan agreement, usually the loan amount, the term of the loan and the interest rate. • Often requires that loan be repaid in full with interest at the end of the loan period. • Usually with a Bank or Financial Institution; occasionally with suppliers or equipment manufacturers
  6. 6. 6 Types of short-termTypes of short-term loans:loans:Line of Credit • The borrowing limit that a bank sets for a firm after reviewing the cash budget. • The firm can borrow up to that amount of money without asking, since it is pre-approved • Usually informal agreement and may change over time • Usually covers peak demand times, growth spurts,etc.
  7. 7. 7 Trade CreditTrade Credit Trade credit is the act of obtaining funds by delaying payment to suppliers, who typically grant 30 days to pay. 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, (furniture sales, Office Max), or borne by the seller as lower profits, or some of both.
  8. 8. 8 Estimation of Cost of Short-TermEstimation of Cost of Short-Term CreditCredit Calculation is easiest if the loan is for a one year period: Effective Interest Rate is used to determine the cost of the credit to be able to compare differing terms. Effective Interest Rate Cost (interest + fees) Amount you get to use = Example:Example: You borrow $10,000 from a bank, at a stated rate of 10%, and must pay $1,000 interest at the end of the year. Your effective rate is the same as the stated rate: $1,000/$10,000 = .10 = 10%
  9. 9. 9 Variations in Loan TermsVariations in Loan Terms A discount loan requires that interest be paid up front when the loan is given. This changes the effective cost in the previous example since you only get to use: ($10,000 - $1,000) = $9,000. Effective rate (APR) = $1,000/$9,000 = .1111 = 11.11%.
  10. 10. 10 Variations in LoanVariations in Loan TermsTermsSometimes lenders require that a minimum amount, called a compensating balance be kept in your bank account. It is taken from the amount you want to borrow. If your compensating balance requirement is $500, then the amount you can use is reduced by that amount. Effective Rate (APR) for a $10,000 simple interest 10% loan with a $500 compensating balance = $1,000/($10,000-$500) = .1053 = 10.53%.
  11. 11. 11 Both Discount InterestBoth Discount Interest and Compensating Balanceand Compensating Balance Sometimes, lenders will require both discount interest (paid in advance) and a compensating balance. If the interest is $1,000 and the compensating balance is $500, then the effective rate (APR) becomes: $1,000 / $10,000 - $1,000 - $500 $1,000 / $8,500 = 11.76%
  12. 12. 12 Cost of Short TermCost of Short Term CreditCreditCost of Trade Credit • Typically receive a discount if you pay early. • Stated as: 2/10, net 60 Purchaser receives a 2% discount if payment is made within 10 days of the invoice date, otherwise payment is due within 60 days of the invoice date. • The cost is in the form of the lost discount if you don’t take it.
  13. 13. 13 Calculating APRCalculating APR (same as(same as EIR)EIR) $ Interest = Rate x Principle x Time i.e. Int = 6% x $1,000 x 90/360 = $15 APR = $ Interest (cost) x 1 $ Net Borrowed Time APR = $15 x 1 / 90 = 1.5% x 4 = 6.0% $1,000 360 Say you have a loan fee of $5.00, then APR = $15 + $5 x 1/90 = 2.0% x 4 = 8.0% 1,000 360
  14. 14. 14 Cost of Trade Credit 2/10 netCost of Trade Credit 2/10 net 6060 Assume your purchase is $100 list price. If you take the discount, you pay only $98. If you don’t take the discount, you pay $100. Therefore, you (buyer) are paying $2 for the privilege of borrowing $98 for the additional 50 days. (Note: the first 10 days are free in this example). APR = $2/$98 x 365/50 = 14.9% (If you pay in 60 days) What if 2%/10, net 30 APR = $2/$98 x 365/20 = 37.25%! (If you pay in 30 days)
  15. 15. 15 Commercial PaperCommercial Paper Commercial paper is quoted on a discount basis, meaning that the interest is subtracted from the face value to arrive at the price. See 3 steps below for calculation: Step 1: Compute the discount (D) from face value of the commercial paper • Discount (D) = (Discount rate x par x DTG)/365 • DTG = days to go (to maturity) Step 2: Compute the price = Face value - Discount Step 3: Compute Effective Annual Rate (APR): $ interest you pay/ $ you get to use
  16. 16. 16 Cost of Commercial PaperCost of Commercial Paper ExampleExample$1 million issue of 90 day commercial paper quoted at 4% discount rate. Step 1:Step 1: Calculate D = .04 x $1 mill. x 90 = $10,000 360  Step 2:Step 2: Calculate price (amount you get) = $1,000,000 - $10,000 = $990,000  Step 3:Step 3: Calculate effective rate (APR) = $10,000 / $990,000 = 1.010% x 4 = 4.04%
  17. 17. 17 Accounts Receivable asAccounts Receivable as CollateralCollateralA pledge is a promise that the borrowing firm will pay the lender any payments received from the accounts receivable collateral in the event of default. Since accounts receivable fluctuate over time, the lender may require certain safeguards to ensure that the value of the collateral does not go below the balance of the loan. So, normally a bank will only loan you 70 -75% of the receivable amount Accounts receivable can also be sold outright. This is known as factoring.
  18. 18. 18 Cost of Borrowing against ReceivablCost of Borrowing against Receivabl Average monthly sales = $100,000 60 day terms, so average Acct Rec balance = $200,000 Bank loans 70% of Accts Rec = $140,000 Interest is 3% over prime (say 8%) = 11% x $140,000 = $15,400 1% fee on all receivables = 1% x $100,000 x 12 = $12,000 APR = $15,400 + $12,000 x 1/1 = 19.57%! $140,000
  19. 19. 19 Inventory as CollateralInventory as Collateral A major problem with inventory financing is valuing the inventory. For this reason, lenders will generally make a loan in the amount of only a fraction of the value of the inventory. The fraction will differ depending on the type of inventory. If inventory is long lived, i.e. lumber, they (lender or a customer) may loan you up to 75% of the resale value. If inventory is perishable, i.e., lettuce, you won’t get much 
  20. 20. 20 DIFFERENT FINANCINGDIFFERENT FINANCING OPTIONSOPTIONS
  21. 21. 21 QUESTIONS TO ASK WHENQUESTIONS TO ASK WHEN LOOKING FOR FINANCINGLOOKING FOR FINANCING WHAT AMOUNT DO I NEED? HOW DO I RAISE THE FUND? IS IT THROUGH EQUITY OR DEBT? WHAT INFORMATION DO I NEED TO PROVIDE THE LENDER/INVESTOR WHAT ARE THE REPAYMENT TERMS? DO I HAVE TO PAY INTEREST? IF SO, WILL IT VARY OVER TIME OR FIXED? HOW LONG WILL IT TAKE TO ACQUIRE THE FUNDS?
  22. 22. 22 QUESTIONS LENDERS WILLQUESTIONS LENDERS WILL ASK BEFORE TAKINGASK BEFORE TAKING DECISIONDECISION INFORMATION TO DERTERMINE HOW THE BUSINESS IS MANAGED THE SIZE OF THE LOAN AS COMPARED TO HOW MUCH YOU HAVE COMPANY’S ABILITY TO LIQUIDATE ITS CURRENT ASSETS
  23. 23. 23 FINANCING METHODSFINANCING METHODS SHORT TERM FINANCING LONG TERM FINANCING
  24. 24. 24 SHORT TERM LOANSSHORT TERM LOANS Use for seasonal build-ups of inventory and receivables, as well as to take advantage of supplier discounts or pay lump-sum expenses, such as taxes or insurance. Repayment is usually in a lump sum with interest at maturity Short-term loans are generally made on a secured (or collateralized) basis and are for a term of a year or less.
  25. 25. 25 CREDIT LINESCREDIT LINES The lender, usually a bank, supplies a business with funds intended to fill temporary shortages in cash that are brought about by timing differences between cash outlays and collections. They are typically used to finance inventories, accounts receivable or for project or contract related work. A track record is often needed before approving a credit line and collateral may be required. Banks will generally require maintenance of certain balances of funds in your commercial bank account.
  26. 26. 26 ASSET - BASEDASSET - BASED FINANCINGFINANCINGA lender accepts as collateral the assets of a company in exchange for a loan. The loan is used as a source of funds for working capital needs. Most asset based loans are financed against accounts receivable since they self-liquidate in a short period of time by themselves
  27. 27. 27 FACTORINGFACTORING Similar to accounts receivable financing with one notable exception.  Factors actually buy your receivables and rely on their own credit and collection expertise. Essentially, your customers become their customers. Payments are made directly to the factor by your buyer. Factoring is generally used by firms unable to obtain bank financing. As a result, the cost of factoring is usually higher than other forms of short-term financing.
  28. 28. 28 TERM LOANSTERM LOANS Use to finance your permanent working capital, purchase of new equipment, construction of buildings, business expansion, refinance existing debt and business acquisitions. Term loans are repaid from the long-term earnings of the business. Therefore, projected profitability and cash flow from operations are two key factors lenders consider when making term loans. Generally, interest rates on long- term loans are higher than for short-term loans.
  29. 29. 29 LEASINGLEASING This has become a significant source of intermediate-term financing for small companies in recent years. Any type of fixed asset may be financed through a leasing arrangement. Leasing can be accomplished through a leasing company, commercial bank, the equipment owner or a commercial finance company. Leasing offers a great deal of flexibility as it can be used to finance even small amounts. The leasing company will be particularly interested in the cash flow of your company.
  30. 30. 30 VENTURE CAPITALVENTURE CAPITAL One problem many new businesses face is raising sufficient capital. A business in its primary phase will also face a difficult challenge getting a bank loan. Venture capital firms offer capital in exchange for equity in a company. This type of financing is ideal for new businesses since venture capital firms focus mainly on the future prospects of a company when banks use past performance as a primary criteria.
  31. 31. 31 LETTER OF CREDITLETTER OF CREDIT A letter of credit is a guarantee from a bank that a specific obligation will be honored by the bank if the borrower fails to pay. Letters of credit can be useful when dealing with new vendors who may not be assured of a company's credit worthiness. The bank would then offer a letter of credit as an assurance to the vendor of payment. Although no funds are paid by the bank.
  32. 32. 32 ANGEL INVESTINGANGEL INVESTING Angel investor or Business angel is an affluent individual who provides capital for a start – up business usually in exchange for convertible debt or ownership equity A small but increasing number of angel investors are organizing themselves into angel networks or angel groups to share research and pool their investment capital.
  33. 33. 33 PRIVATE EQUITY FUNDS A fund that invests in companies and/or entire business units with the intention of obtaining a controlling interest (usually by becoming a majority shareholder, sometimes by becoming the largest plurality shareholder) so as to be in the position of restructuring the target company's reserve capital, management, and organizational infrastructure.
  34. 34. 34 THANK YOU

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