SMALL BUSINESS FINANCE CHAPTER 14 Short-Term Capital

1. Small Business Finance
Ch 14: Short Term Capital

2. • Short-term finance refers to sources of finance for a small
period, normally less than a year. In businesses, it is also
known as working capital financing. This type of financing is
usually needed because of the uneven cash flow into the
business, the seasonal pattern of business, etc. In most cases,
it is used to finance all types of inventory, accounts
receivables, etc. At times, only specific one-time orders of
business are financed.
•
A credit used in the process of production and distribution
for the circulation of working capital or of circulating assets.
 Such credit is usually granted for a period of up to one year.
Short Term Capital

3. Importance of Short term debt for small business
 Satisfy the operating capital needs of a business.
Keep a business running during times when the revenue
stream temporarily is insufficient to meet operational needs.
 Short term financing plays a vital role in the financing of
assets, regardless of the size of the firm.
 Limited access to the capital markets.
Short Term Capital

4. Factors Influencing The Decision Between Short Term And
Long Term
In determining the financing policies of the firm. two
underlying questions must be resolved:
(I) What is the optimal debt-equity relationship
(2) what should be the composition of debt in terms of
shore term and Long term maturities?
Short Term Capital

5. Advantages and reasons for using short term debt
 Easy to obtain
 Seasonal or cyclical requirement
 Cost of debt
 Penalties in case of nonpayment
 Emergency Funding
 Expansion
Short Term Capital

6. Reasons of using long term debt
 Reduced interest rate risk
 Loan renegotiation
 more time to pay off loan
 reduces dependence on any one capital
source
 used to finance major purchases
 expansion projects
Short Term Capital

7. Firms characteristics and the debt maturity structure
The level of business risk
Existing asset structure
Company size & maturity
Book
Short Term Capital

8. Sources of Short Term Credit
Sources of short term credit segmented in to three categories
1. Credit available in the form of trade credit.
2. Debt provided by financial institutions.
3. Capital available through government
agencies.
Sources of Short Term Credit

9. 1. Trade Credit
Trade credit is an arrangement between
businesses to purchase goods or services
without making immediate cash payment.
The supplier provides the customer with an
agreement to bill in a stipulated number of
days.
Sources of Short Term Credit

10. Characteristics Of Trade Credit
 Informal agreement no computable cost is
associated with tread credit
 The term of trade credit normally range from
30 to 180 days.
 A discount might be allowed on early
payment.
 The only mode of financing available to
finance inventories.
Short Term Capital
Sources of Short Term Credit

11. Cost of trade credit
formula for the cost of credit
Discount % x 360 or 365 days
100-Discount % Allowed payment days – Discount days)
Short Term Capital
Sources of Short Term Credit

12. 2. Financial Institutions As Suppliers O f Short Term Credit
a. Commercial banks
o Banks have been one of the major sources of
short and intermediate term capital for the
business firms.
o In some cases a business firm will rotate loans
among banks.
o Line of credit.
Short Term Capital
Sources of Short Term Credit

13. Financial Institution (commercial Banks)
Cost of bank credit
The cost of short term credit is determined by
several factors, three of which are;
– State of the economy at the time of loan.
– Credit status of the firms.
– The cost of processing the loan.
Compensating Balance
Short Term Capital
Sources of Short Term Credit

14. Financial Institution (commercial Banks)
Asset Financing by Bank
• The use of specific collateral to acquire a loan has
come to be termed “asset financing”.
Short Term Capital
Sources of Short Term Credit

15. Advantages of bank credit
• Advice and counsel can be obtained from experts in finance.
• Credit information is available.
• Banks are a source of information regarding potential mergers
and consolidations.
• Aid with regards to future financing is obtained.
• Banks provide contact with other sources of capital.
• Banks are major sources of both-short and intermediate term
capital.
Short Term Capital
Sources of Short Term Credit

16. Disadvantages of bank credit
• Confidential information must be revealed if
loans are to be secured.
• Firms are compelled to maintain compensating
balances, and this increases the cost of funds.
• Periodic reports are usually required by banks.
• Banks often demand that they be allowed to
ratify managerial decisions.
Short Term Capital
Sources of Short Term Credit

17. Financial Institution (commercial Banks)
Reasons For Denying Credit
There are at least three basic reasons that banks
deny credit to business.
1. Bank Policies
2. Creditworthiness
3. Incomplete Information
Short Term Capital
Sources of Short Term Credit

18. The Loan Application
In applying for a loan, most banks have a standard loan request form.
However, regardless of the formal, certain information is essential.
A. Define the loan request
– Purpose
– Amount required
– Term requested (Duration)
– Sources of repayment
– Collateral available
B. History and nature of the business
C. Management (resume on each management person and the
function he or she provides).
Short Term Capital
Financial Institution (commercial Banks)

19. The Loan Application
D. Financial information
– Balance sheet & income statement for past three years
– Last three years tax returns
– Personal financial statements
– Performa income & cash flow statements for next year
E. General Information
– Industry trends
– Marketing techniques
– Competition
– Aged accounts receivable
– Aged accounts payable
Financial Institution (commercial Banks)

20. Financial Institution
b. Finance companies
 Consumer finance companies.
 Sales finance companies.
 Business finance companies.
Short Term Capital
Sources of Short Term Credit

21. Financial Institution( Finance companies)
Factors
• The factor is one of the oldest financial institutions,
and yet it is probably one of the least known.
• Factor is responsible for financing and the credit &
collection of amount whereas distribution is done by
manufacturer.
Short Term Capital
Sources of Short Term Credit

22. Financial Institution( Finance companies)
Functions of Factors
• Purchasing accounts receivables
• Credit & Collection
• Providing advisory services
Short Term Capital
Sources of Short Term Credit

23. Financial Institution( Finance companies)
Cost of Factors
The factor’s charge includes two major
components:
• First, a fee for performing the credit and
collection function and for purchasing the firm’s
receivables without recourse for credit losses,
• Second, an interest rate charge on funds loaned
to the business firm.
Short Term Capital
Sources of Short Term Credit

24. Financial Institution( Finance companies)
Cost of Factors
The first of these costs, the commission rate, is determined
through negotiation: it is influenced by several considerations:
• Type of industry
• Volume of sales
• Average size of sale
• Average annual sales volume per customer
• Credit standing of the firms customers and,
• Credit terms offered by the firm
Short Term Capital
Sources of Short Term Credit

25. Financial Institution( Finance companies)
Cost of Factors
The commission rate is expressed as a
percentage of the full net face value of the
receivables sold: it generally ranges from 1 to
2%.
Short Term Capital
Sources of Short Term Credit

26. 3. Government Agencies
The small business Administration
SBA perform variety of functions, such as;
 Ensuring small business a “fair” proportion of government
contracts.
 Either loaning or acting as the guarantee for credit
extended to the small firm.
 Providing management consultants to the owners of the
small company.
 Performing research of interest to the small business
community.
Short Term Capital
Sources of Short Term Credit

27. 3. Government Agencies
Eligibility requirements for SBA loans
To be considered a small firm, for the purpose of SBA interest, the
following criteria, as appropriate, must be met.
Retailing - annual sales/receipts not exceeding $3.5 to $13.5 million,
depending on the industry.
Services - annual receipts not exceeding $2.5 to $14.5 million, depending
on the industry.
Wholesaling - yearly sales must not be over $9.5 to $22 million,
depending on the industry.
Agriculture - annual receipts not exceeding $1.0 to $3.5 million,
depending on the industry.
Construction - General construction - annual receipts not exceeding $17
million.
Short Term Capital
Sources of Short Term Credit

28. Government Agencies
Application procedure
For established organizations, the required information is filing for the
SBA loan would include the following.
 Company background.
 Current balance sheet.
 Income statements for several recent years.
 Budget projections for the forthcoming year.
 Current personal financial statements for the owners, including any
individual having at least a 20% interest in the firm.
Short Term Capital
Sources of Short Term Credit

29. Government Agencies
Application procedure
If the firm is new, the proprietors should provide any of
the foregoing information that is available. In addition,
data relating to the following areas are to be provided:
 A detailed description of the new business.
 A presentation of management experience.
 An indication of the total financing required and the
amount of other financing sources, including private
capital being invested.
Short Term Capital
Sources of Short Term Credit

30. Government Agencies
Types of Loans
 The SBA offers two basic types of loans.
 First are loans made by private lenders, usually banks,
and guaranteed by the SBA. The bank or private lender
may obtain a guarantee of the loan repayment from
the SBA not to exceed the lesser of 90% of the loan or
$ 500,000.
 The second type of assistance is for the SBA to make
direct loans to firms unable to secure funds from
private sources. Loan of this nature cannot exceed $
150,000.
Short Term Capital
Sources of Short Term Credit