Business Finance

Prepared By:
Dr. H. M. Mosarof Hossain
Professor
Department of Finance
University of Dhaka
mosarof@du.ac.bd

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 Chapter Three: Short Term Financing

Definition:
Required amount of fund collected by a business enterprise
for running day to day operations and meeting up
emergencies from different available sources for less than
one year time period is known as short term financing.

Types of short term financing:

(A)Spontaneous short term financing
(a) Trade credit ( open account and notes payable)
(b) Advance receipts from customers and deferred
income
(c) Accrued expenses

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 Types of Short Term Financing

(B) Negotiated short term financing

(a) Short term bank loans (establishing a bank
relationship, loan analysis, types of short term
bank loans)
(b) Open market loans (commercial paper,
secured loans, factoring receivables, pledging
receivables, inventory loans).

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 Types of Short Term Financing
(i)Cost of trade credit: A business can purchase
materials for Tk.100000 on credit terms 3/30, net 90.
What is the cost of this trade credit?
Cost of trade credit or foregoing cash discount
= % cash discount/(100% - % cash discount)X
(365/Difference between due date and discount date or
net period)
= 3%/(100%-3%)X(365/60)=18.81%
(ii)Cost of short term bank loans: National
housing ltd. Has negotiated Tk.200000, 180 days, 8%
loan with Brac bank ltd. Calculate the effective cost of
this loan under loan discounting, 10% compensating
balance, considering 35% tax and no applying
bankers’ year. 4
 Types of Short Term Financing

Interest amount = 200000X0.08X180/365=7890

Compensating balance = 200000X0.10=20000
Net loan proceed = 200000 - 7890 – 20000 = 172110
Effective cost before tax = (7890/172110)X(365/180)=9.30%
Effective cost after tax = 9.30% (1-0.35)= 6.05%
(iii)Cost of commercial paper: A commercial
paper with face value Tk.1000 sold for Tk.950 for 120
days. What is the cost or yield of this paper?
cost or yield of commercial paper= [(FV-SV)/SV]X(365/t)
= [(1000-950)/950]X(365/120)= 16.01%

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 Types of Short Term Financing

(iv)Cost of factoring receivables: (a) A

company’s annual credit sale is Tk.1000000 and average
collection period is 72 days. A factor is ready to pay
advance by factoring the receivables @ 16% interest rate
for 85% face value. Factoring charge is 1.5%, accounts
receivable administration cost and bad debt loss is
Tk.5000 p/a. What is the effective cost factoring
receivables?
Average level of accounts receivable= Annual credit sale X
Average collection period/360 days = 1000000X72/360
=200000
Reserve to be maintained = 200000X0.15= 30000
Periodic factoring commission = 200000X0.015=3000
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 Types of Short Term Financing

Periodic interest expense=[(200000-30000-

3000)X0.16X72]/360 = 5344
Net fund received = 200000-30000-3000-5344=161656
Accounts receivable turnover = 360/72= 5X
Annual interest expense = 5344X5= 26720
(+) Annual factoring commission = 3000X5= 15000
(-) Administration cost and bad debt loss 5000
Net cost of factoring receivables 36720
Effective interest cost = 36720/161656=22.71%.

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 Types of Short Term Financing

(b) A company needs Tk.80000 to meet working capital

requirement immediately. It has three alternative
sources such as to purchase required materials for
Tk.100000 on 3/30, net 90; to take loan Tk.100000 @
13% interest with 20% compensating balance; to sale
receivables to a factor that’s face value Tk.100000 p/m
@ 12% interest by maintaining 20% reserve, paying 2%
commission where average collection period is 60
days, receivable administration cost is Tk.1000 p/m
and 1% bad debt loss. Comment about financing.

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 Types of Short Term Financing

Cost of trade credit= (3/97) X (360/60) = 18.56%

Cost of bank loan:
Interest amount = (100000X0.13) X(60/360)= 2167
Compensating balance = 100000X0.20= 20000
Net fund = 100000 – 20000 = 80000
Effective interest rate = (2167/80000) X ( 360/60) = 16.25%
Cost of factoring receivables:
Average level of receivable = 100000X12X60/360= 200000
Accounts receivable turnover = 360/60= 6X
Periodic factoring commission = 200000X0.02= 4000
Reserve to be maintained = 200000X0.20= 40000
Periodic interest expense = (200000-40000-4000)X0.12X60/360= 3120
Net fund = 200000-4000-40000-3120= 152880
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 Types of Short Term Financing

Annual interest expense= 3120X6 = 18720

Annual factoring commission =4000X6= 24000
Annual cost of credit administration =1000X12= 12000
Annual ad bad debt loss = 1200000X0.01= 12000
Net cost of factoring receivables = 18720
Effective interest rate = 18720/152880= 12.25%
Factoring receivables financing is recommended.

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 Types of Short Term Financing

Features of short term financing:

Time period
Purpose
Cost of capital and risk
Security (no)
Recycling
Renewal

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