Chapter

Sources of Short-Term Financing

PPT 8-2

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 ‹ PPT 8-3 .

Figure 8-1 PPT 8-4 Structure of corporate debt. 2000 .

the full amount is due in 30 days . 2/10 net 30 means a 2% discount is given if paid in 10 days. if not..PPT 8-5 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.

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.Net Credit Position Net Credit Position: PPT 8-6 a firm’s Accounts Receivable (A/R) minus its Accounts Payable (A/P) ‹ if A/R is greater than A/P. 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: ‹ ‹ ‹ .

scotiabank.html http://www.cibc.Chartered Banks in Canada http://www.ca PPT 8-7 .com/ http://www.rbc.nbc.tdbank.html http://www.bmo.com/ http://www.com/index.com/ http://www.ca/index.

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 .

PPT 8-9 Interest Rate Terminology Prime Rate: the interest rate charged to a bank’s 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 PPT 8-10 Prime interest rate movements .

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.PPT 8-11 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.S Eurodollars predominate) foreign interest rates may be lower Bankers’ Acceptances ‹ ‹ Eurodollar Loans: ‹ ‹ .

Figure 8-3 PPT 8-12 Corporate short-term paper outstanding .

Figure 8-4 Comparison of commercial paper rate to bank prime rate* PPT 8-13 .

PPT 8-14 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 .

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

‹ ‹ ‹ ‹ Commission of 1%-3% of factored invoices Interest on advances . Factoring costs. to a factoring firm.Factoring Receivables ‹ Receivables are sold. usually without recourse. A factor provides a credit-screening function by accepting or rejecting accounts.

Credit ratings often are better than the issuing firm. Several problems must be resolved: ‹ ‹ ‹ ‹ Image: Historically. car loans and credit car receivables. firms that sold receivables were considered to be in financial trouble. Probability of losses on default of underlying securities. . Computer upgrading to service securities.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.

‹ Price Stability ‹ Perishability ‹ Physical control ‹ . ‹ Standardized products or widely traded commodities qualify for higher percentage loans. ‹ The collateral value of inventory is based on several factors. ‹ Marketability Raw materials and finished goods are more marketable than goods-in-process inventories.Inventory Financing ‹ Inventory LT 8-8 may be assigned as collateral security against an operating loan.

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

Longer-term Loans ‹ Term ‹ LT 8-9 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 PPT 8-16 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 borrower’s need for working capital. and incur interest based upon the prime rate .

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