Chapter

Sources of Short-Term Financing

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Chapter 8 - Outline
Sources

of Short-Term Financing Trade Credit from Suppliers Net Credit Position Chartered Banks in Canada Types of Short-term Loans Interest Rate Terminology Corporate and Foreign Borrowing Accounts Receivable Financing Inventory Financing Summary and Conclusions

Sources of Short-Term Financing

There are various sources of short-term funds available to a firm:
Trade Credit from Suppliers Bank Loans Corporate Promissory Notes Bankers Acceptances Foreign Borrowing Loans Against Receivables and Inventory

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Figure 8-1

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Structure of corporate debt, 2000

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Trade Credit from Suppliers

The

largest source of short-term financing for a firm-over 50% It is usually a 30-60 day grace period before a bill is due A cash discount is often given if payment is made within a specified time

Ex., 2/10 net 30 means a 2% discount is given if paid in 10 days; if not, the full amount is due in 30 days

Net Credit Position

Net Credit Position:

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a firms Accounts Receivable (A/R) minus its Accounts Payable (A/P) if A/R is greater than A/P, it is a net provider of trade credit (positive number) if A/P is greater than A/R, it is a net user of trade credit (negative number) larger firms tend to be net providers of trade credit, while smaller firms are net users

PPT 8-8

Types of Short-term Bank Loans

Line of Credit:

company is able to draw upon a yearly borrowing facility arranged in advance revolving credits are for periods longer than 1 year general purpose loans short-term loan for a specific purpose when a bank requires a minimum average account balance in order to qualify for a loan can be thought of as a form of collateral less common than in the past

Transaction Loan:

Compensating Balance:

Chartered Banks in Canada

http://www.rbc.com/ http://www.cibc.com/index.html http://www.bmo.com/ http://www.scotiabank.com/ http://www.tdbank.ca/index.html http://www.nbc.ca

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Compensating Balance:
when

a bank requires a minimum average account balance in order to qualify for a loan be thought of as a form of collateral and compensate the bank for its service balances raise the cost of a loan, the borrower must borrow more than the amount needed
Amount borrowed = amount needed/ (1-C)

can

Compensating

less

common than in the past

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Interest Rate Terminology

Prime Rate:
the interest rate charged to a banks best customers acts as a benchmark for calculating other interest rates

Effective Interest Rate:

the actual interest rate or true cost of a loan, including interest on interest (compounding)

Figure 8-2

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Prime interest rate movements

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Corporate and Foreign Borrowing

Commercial Paper:

a short-term unsecured promissory note in minimum units of $50,000 sold (at a discount) by finance companies, other large corporations cheaper than bank loans total amount of commercial paper outstanding has increased greatly in recent years to finance goods in transit (particularly imports) sold at a discount loans from foreign banks are called Eurodollar loans (U.S Eurodollars predominate) foreign interest rates may be lower

Bankers Acceptances

Eurodollar Loans:

Figure 8-3

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Corporate short-term paper outstanding

Figure 8-4

Comparison of commercial paper rate to bank prime rate*

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Accounts Receivable Financing

A/R financing includes 3 choices:
pledging accounts receivable as collateral for a loan an outright sale (factoring) of receivables to a factoring company Asset-backed Securities: sale of receivables by large corporations in public offerings

Tends to be a relatively expensive source of financing

Pledging accounts of receivable as collateral

Convenient means of financing. Receivables levels are rising as the need for financing is increasing. Lender screens accounts and loans a percentage (60% 75%) of the acceptable amount. Lender has full recourse against borrower. The interest rate, which is usually in excess of the prime rate, is based on the frequently changing loan balance outstanding.

Factoring Receivables

Receivables are sold, usually without recourse, to a factoring firm. A factor provides a credit-screening function by accepting or rejecting accounts. Factoring costs.

Commission of 1%-3% of factored invoices Interest on advances

Asset-backed public offerings

Public offerings of securities backed by receivables as collateral is a recently employed means of short-term financing. These have included mortgages, car loans and credit car receivables. Credit ratings often are better than the issuing firm. Several problems must be resolved:

Image: Historically, firms that sold receivables were considered to be in financial trouble. Computer upgrading to service securities. Probability of losses on default of underlying securities.

Inventory Financing
Inventory

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may be assigned as collateral security against an operating loan. The collateral value of inventory is based on several factors.

Marketability
Raw materials and finished goods are more marketable than goods-in-process inventories. Standardized products or widely traded commodities qualify for higher percentage loans.

Price Stability Perishability Physical control

Inventory control method

Blanket inventory liens: Lender has general claim against inventory of borrower. No physical control. Trust receipts: Also known as floor planning; the borrower holds specifically identified inventory and proceeds from sale in trust for the lender. Warehouse: Goods are physically identified, segregated, and stored under the director of an independent warehousing company. Inventory is released from warehouse openly upon presentation of the warehouse receipt controlled by the lender.

Longer-term Loans
Term

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Loan (Instalment Loan):

loan for 1-7 years interest rate may be fixed or change with prime rate repaid in monthly or quarterly instalments used to buy capital assets (ex; automobiles, property)

Summary and Conclusions

Short-term

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financing options

include: trade credit from suppliers bank operating loans commercial paper for large companies Eurodollar or foreign currency loans financing secured by accounts receivable or inventory Bank operating loans move up or down based upon the borrowers need for working capital, and incur interest based upon the prime rate