FINANCIAL MANAGEMENT 1

SOURCES OF SHORT-TERM FINANCING

SHORT-TERM FINANCING
Short-term financing refers to debt originally scheduled for repayment within one year. Short-term financing is
used to finance all or part of the firms working capital requirements and sometimes to meet permanent financing
needs.

I. TRADE CREDIT
Definition: A trade credit is an agreement where a customer can purchase goods on account (without paying
cash), paying the supplier at a later date.
Accounts payable is a spontaneous source of funds, growing as the business expands on a seasonal or long-
term basis and contracting in a like fashion when business declines.
Payment period
Definition: The period over which the borrower is obliged to make payments.
Trade credit is usually extended for 30 to 60 days (stretching the payment period)
Cash Discount Policy
Cash discount is the reduction in price if the payment is made within a specified time period. Ex. 2/10, n/30
% 360
Cost of failing to take a cash discount = x
100% %
Net Credit Position
It is the measure relationship of accounts receivable and accounts payable.
Accounts Receivable > Accounts Payable
Accounts Receivable < Accounts Payable

II. BANK CREDIT

Banks may provide funds for financing of seasonal needs, product line expansion and long term growth.
Self-liquidating loan is a type of short- or intermediate-term credit in which the use of funds will ensure a built-in
or automatic repayment scheme.
Prime Rate
It is the rate a bank charges its most creditworthy customers, and it usually increases as customers credit risk
gets higher.
Compensating Balances
It is a bank requirement that business customers maintain a minimum average balance.
Maturity Provisions
Term loan is an intermediate-term loan in which credit is extended for one to seven years. The loan is usually
repaid in monthly or quarterly installments over its life rather than in one single payment.
Cost of Commercial Bank Financing
360
Effective rate = x

360
Effective rate on discounted loan = x

Interest Costs with Compensating Balances

Effective rate with compensating balances =
1
Rate on Installment Loans
2 x # x
Effective rate on installment loan =
( . + 1) x
Annual Percentage Rate (APR)
Truth in Lending Act of 1968 in US mandated that all banks should give APR to borrowers.
It is the annual rate charged for borrowing or earned through an investment, and is expressed as a percentage
that represents the actual yearly cost of funds over the term of a loan.

III. FINANCING THROUGH COMMERCIAL PAPER

Definition: A commercial paper is a short-term, unsecured promissory note that large corporations issued to public
(investors).
Categories of Commercial Paper
1. Finance paper or direct paper issued directly by large financial firms
2. Dealer paper issued by industrial companies, utility firms or small financial companies
3. Asset-backed commercial paper issued by a bank or other financial institution and these notes are backed by
physical assets such as trade receivables
Advantages of Commercial Paper
1. Lower interest compare to prime rate
2. Less costly
 3. Give prestige to companies (make companies part of snobbish market)
Limitations/Disadvantages of Commercial Paper
1. the fixed maturity date which raises the liquidity risk
2. its lack of user availability except for very large firms

IV. FOREIGN BORROWING

5 Cs of Credit PLUS 2 Considered by Foreign Creditors
1. Character 2. Capital 3. Capacity
4. Conditions 5. Collateral
6. COUNTRY refers to the government status or situation where the debtor is located
7. CURRENCY refers to the currency risk of the borrowing firm

V. USE OF COLLATERAL IN SHORT-TERM FINANCING

Preferable if the borrowers credit rating is too low
Collateral is merely a stopgap device to protect the lender when all else fails.
Most preferred collateral for short-term financing are the accounts receivables and inventory.

VI. ACCOUNTS RECEIVABLE FINANCING

Definition: Accounts receivable financing may include pledging accounts receivable as collateral for a loan or an
outright sale (factoring) of receivables.
Pledging Accounts Receivable
Companies may borrow 60 to 90% of the value of acceptable collateral depending on the financial strength of
the borrowing firm
The interest rate in receivables borrowing arrangement is generally well in excess of the prime rate.
Factoring Accounts Receivables
When we factor receivables, they are sold outright to the finance company.
No recourse
For taking the risk, the factoring firm is generally paid on a fee or commission equal to 1 to 3% of the invoices
accepted.
Asset-backed Public Offerings
Public sale of receivables

VII. INVENTORY FINANCING

Stages of Production
Raw materials and finished goods are likely to provide the best collateral. (if widely traded, 70 to 80% or may be
higher)
Goods in process may qualify for only a small percentage loan. (25% or less)
Nature of Lender Control
Blanket Inventory Liens. It is the simplest method for lender because it has general claim against the inventory of
the borrower.
Trust Receipts. It is an instrument acknowledging that the borrower holds the inventory and the proceeds from
sales in trust for the lender.
Warehousing. Under this arrangement, goods are physically identified, segregated and stored under the
direction of an independent warehousing company.

VIII. HEDGING TO REDUCE BORROWING RISK

Definition: Hedging means to engage in a transaction that partially or fully reduces a prior risk exposure.
Financial future market is set up to allow for trading of financial instrument at a future point in time

Reported by: Jherry Mig Sevilla, BSA3

References:
Block, Stanley B., et al. 2009. Foundations of Financial Management. McGraw-Hill/Irwin
Cabrera, Ma. Elenita B. 2015. Financial Management Principles and Applications, Vol. 1. GIC Enterprises & Co. Inc.
http://www.investopedia.com/