SOURCES OF SHORT-

TERM FUNDS
CONSTRUCTION GROUP

Members:
Emmanuel Pagalunan Ria Lorraine Mendez
Jayson Villarin Samantha Kate Fortunado
Riabelle Berdan Rouzel Rubian
Abegael Mechilina
LEARNING OBJECTIVES

• To know what is short-term funds

• The need for short-term financing
• To determine the sources of short-term funds
• Compute the cost of short-term funds
 WHY DO FIRMS NEED SHORT-TERM FINANCING?

Cash flow from operations may not be sufficient to keep up with growth-related
financing needs.
Firms may prefer to borrow now for their inventory or other short term asset needs
rather than wait until they have saved enough.
Firms prefer short term financing instead of long-term sources of financing due to:
• Easier availability
• Usually has lower cost
• Improve credit rating
Sources of Short-term Funds

1. Trade Credit
2. Bank Loans
3. Commercial Paper
4. Receivable factoring
5. Credit Lines
6. Revolving Credits
 1. Trade Credit

Trade credit is the act of obtaining funds by

delaying payment to suppliers who typically grant 30
days to pay.
Trade credit provides small businesses with several
benefits.

• Easy availability when compared to other sources of

finance (except financially weak companies)
• An agreement is relatively easy to maintain, as long as
the conditions are met
• Can be used by most business (for supplies of goods or
service)
Trade credit does have some disadvantages, too.

• Possible loss of early payment discount

• Failure to comply with the conditions could lead to the
loss of a supplier
• There are no guarantees, as customer may pay late.
Trade Credit Example

Suppose for example, a business receives invoices from

suppliers for the amount of 5,000 with 30 day terms
offering a 1% early payment discount for settlement within
14 days (1/14 net 30 terms).
 2. Bank loans

Commercial bank lending appears on the balance

sheet as notes payable and is second in importance to
trade credit as a source of short-term financing.
 A single loan obtained from a bank by a business firm
is not different in principle from a loan obtained by an
individual. The firm signs a conventional promissory note.
Repayment is made in a lump sum at maturity or in
installments throughout the life of the loan.
Promissory Notes

A promissory note is a financial instrument that contains a

written promise by one party (the note's issuer or maker) to
pay another party (the note's payee) a definite sum of
money, either on demand or at a specified future date.
 3. Commercial Paper

Commercial paper is a commonly used type of

unsecured, short-term debt instrument issued by
corporations, typically used for the financing of payroll,
accounts payable and inventories, and meeting other
short-term liabilities.
• Maturity: Not more than 270 days from the date it was issued.
• As commercial papers do not usually have any security backing,
only blue chip companies can sell them. Typically, they sell them at a
discount from face value. In some cases, they may have the backing
of mortgages or other types of loans.
• Because commercial paper is issued by large institutions, the
denominations of the commercial paper offerings are substantial,
usually $100,000 or more. Other corporations, financial institutions,
wealthy individuals, and money market funds are usually buyers of
commercial paper.
• Major Benefit: It does not need to be registered with the Securities
and Exchange Commission (SEC) as long as it matures before
nine months, or 270 days, making it a very cost-effective means of
financing.
• Maturities for commercial paper average about 30 days, rarely
reaching that threshold.
• The proceeds from this type of financing can only be used on
current assets, or inventories, and are not allowed to be used on
fixed assets, such as a new plant, without SEC involvement.
REQUIREMENTS FOR NEGOTIABILITY OF
COMMERCIAL PAPER

• The instrument must be in writing and signed by

either its maker or its drawer.
• It must be either an unconditional promise, as in
the case of a promissory note, or an order to pay a
specific amount of money, such as a draft.
Endorsements
• An endorsement is the process of signing the back of a paper, thereby
imparting the rights that the signer had in the paper to another person.
Liability of Parties
• An individual who signs an instrument is either primarily or
secondarily liable for payment. Primary liability is extended to the
person who is expected to pay first, and the individual who is legally
responsible to pay upon the failure of the first party to do so is
secondarily liable.
• Example: When a retail firm is looking for short-term funding to finance
some new inventory for an upcoming holiday season. The firm needs
$10 million and it offers investors $10.1 million in face value of
commercial paper in exchange for $10 million in cash, according to
prevailing interest rates. In effect, there would be a $0.1 million interest
payment upon maturity of the commercial paper in exchange for the $10
million in cash, equating to an interest rate of 1%. This interest rate can
be adjusted for time, contingent on the number of days the commercial
paper is outstanding.
4. Receivable Factoring

Accounts receivable factoring, also known as

factoring, invoice factoring or accounts receivable
financing, is a financial transaction in which a company
sells its accounts receivable to a financing company that
specializes in buying receivables (called a factor) at a
discount.
• How It Works: A company sells its
receivables to a financial company (called a
factor). The factor collects payment on the
receivables from the company’s customers.
• Advantage: Companies choose factoring if they want to
receive cash quickly rather than waiting for the
duration of the credit terms. Factoring allows
companies to immediately build up their cash flow and
pay any outstanding obligations. Therefore, factoring
helps companies free up capital that is tied up in
accounts receivable and also transfers the default risk
associated with the receivables to the factor.
Factoring fee - is a percentage of the amount of receivables being
factored (may range from 2% to 15%). The rate charged by
factoring companies depends on:
• The industry that the company is in
• The volume of receivables to be factored
• The quality and creditworthiness of the company’s customers
• Days outstanding in receivables (average days outstanding)
• Additionally, the rate depends on whether it is recourse factoring
or non-recourse factoring.
• Recourse Factoring: the factor can demand money
back from the company that transferred receivables if it
cannot collect from customers.
• Non-recourse Factoring: the factor takes on all the risk
of uncollectable receivables. The company that
transferred receivables has no liability for uncollectable
receivables.
Example Non-recourse Factoring:
• Company A transfers $500 million of receivables, without recourse, for proceeds of $400
million. The journal entry would be as follows:

• Note: $100 million is considered interest expense. It shows that the company obtained cash
flow earlier than it would have if it waited for the receivables to be collected.
Example Recourse Factoring:
• Company A transfers $500 million of receivables, with recourse, for proceeds of $450 million less a
$50 million holdback. Later on, the factor is able to collect receivables of $490 million ($10 million
receivables uncollectible). The journal entries are as follows, with the initial journal entry below:

Note: The account “Due from factor” is the potential payment for possible non-collectibles.
• After the factor collected $490 million of receivables ($10 million uncollectible):
 5. Credit Line

A credit line, also known as a line of credit (LOC),

is a type of standing loan that allows individuals,
businesses, or other organizations to borrow cash when
they need it, repay what they have borrowed, and
continue borrowing without applying for a new loan.
TYPES OF CREDIT LINE

1. Credit Cards
2. Home equity line of credit
3. Business credit lines
 HOW DOES A CREDIT LINE WORK?

• A line of credit is different from a traditional loan. With the latter,

you apply for a sum of money and pay it back in installments
within that set time frame. You can't continually take out new
money against the same loan.
• With a credit line, however, you are applying for regular access
to cash when you need it. It's usually understood that you may
take out money repeatedly throughout the life of your loan.
Like other loans, credit lines can be secured
or unsecured. With a secured loan, your
lender requires you to use a personal asset
(or assets) as collateral that the bank can
seize if you default. 
PROS OF CREDIT LINES

• Immediate access to cash

• Only borrow what you need
• Interest-only payments during draw period (if
applicable)
• Continue borrowing as needed
CONS OF CREDIT LINES

• Higher interest rates

• Interest adds up
• Can put assets at risk
• Financial risks
• Unexpected changes
 6. Revolving Credit

Revolving credit is a type of credit that can be

used repeatedly up to a certain limit as long as the
account is open and payments are made on time.
With revolving credit, the amount of available credit
, the balance, and the minimum payment can go up
and down depending on the purchases and
payments made to the account.
 HOW REVOLVING CREDIT WORKS

1. Drawing money- Depending on the type of credit account

you have, how and when you draw money from your
revolving credit account can differ. There are different
possible ways to draw money from an account’s credit line,
like a transfer to your checking account or a purchase.
2. Making payments- Your account balance is reduced by any
payments you make to the account.
NON-REVOLVING CREDIT

Non-revolving credit is different from revolving credit in one major way. It

can't be used again after it's paid off. Examples are student loans and auto
loans that can't be used again once they've been repaid.2
When you initially borrow the money, you agree to an interest rate and a
fixed repayment schedule, usually with monthly payments. Depending on
your loan agreement, there may be a penalty for paying off your balance
ahead of schedule.
REVOLVING VS. NON-REVOLVING CREDIT

While non-revolving credit often has a lower interest rate and

predictable payment schedule, it doesn't have the flexibility of
revolving credit. You can use revolving credit for a variety of
purchases as long as you stick to the credit card terms.
On the other hand, non-revolving credit has more purchasing power
because you can be approved for higher amounts, depending on your
income, credit history, and other factors. Because of the risk involved,
banks often limit the amount you can borrow on revolving credit.
 Estimating Cost of Short-term Funds

1. Nominal Annual Rate

2. Effective Annual Rate
3. Annual Cost of Trade Credit
NOMINAL INTEREST
RATE
RIABELLE BERDAN
NOMINAL INTEREST RATE
• The nominal interest rate (or money interest rate) is the percentage increase in
money you pay the lender for the use of the money you borrowed.
• It is also known as stated interest rate or annual percentage rate.
• Nominal can also refer to the advertised or stated interest rate on a loan,
without taking into account any fees or compounding of interest.
• The nominal interest rate is often used in banks to describe interest on different
loans and in the investment field to suggest investors for investments in the
market.
PROBLEM
You are a personal finance expert advising two clients:
• Angela, who must choose between two payday loans, each for P3,000 and 14-
days: Loan A with financial charge of P100 payable at the end of 14th day and
Loan B with finance charge of P90 deducted from the principal balance at the
start of the loan.
• Antonio, who wants to identify better investment for his P50,000 for 5 years:
Investment E paying APR of 10.6% compounded semiannually and
Investment F with effective interest rate of 11% compounded monthly.
SOLUTION
In case of Angela, Loan B is better. This is because annual percentage rate (APR) of Loan B is lower than APR for the Loan A.
APR of Loan A is 86.9% worked out through the following steps:
Nominal
•calculating periodic interest rate, which equals 3.33% (=P100/P3,000) for 14-day period,
Nominal Annual Rate
•annualizing the rate by dividing it by the term of the loan (14) and multiplying by the number of days in a year ( 3.33%/14×365 = 86.9%).

APR of Loan B is 80.63% calculated as follows:

•finding financial charge for 14 days which is P90,
•finding amount financed, which is P2,910 (P3,000 total amount minus P90 interest because it is paid at the start of the loan)
Nominal
•finding periodic rate for the 14-days which is 3.093% (=P90/P2,910)
Nominal Annual Rate
•annualizing the rate ( 3.093%/14×365=80.63%).
• In case of Antonio, we need to find out Nominal interest rate for Investment F to make a
comparison.

Nominal Interest Rate = 12 × ((1 + 11%)(1/12) – 1) = 10.48%

• Effective annual interest rate (EAR) in case of Investment E is just 10.88% (as shown
below) which is lower than the effective interest rate on Investment F which is 11%.

Effective annual interest rate = (1 + 10.60%/2)2 – 1 = 10.88%

• Antonio should choose Investment F paying 11% effective rate instead of Investment E
paying 10.6% annual percentage rate (APR) compounded semiannually.
EFFECTIVE INTEREST
RATE
SAMANTHA KATE C. FORTUNADO
WHAT IS AN EFFECTIVE INTEREST RATE?
• The effective interest rate is the real return on a savings account or any
interest-paying investment when the effects of compounding over time
are taken into account.
•  It also reveals the real percentage rate owed in interest on a loan, a
credit card, or any other debt.
• The effective annual interest rate is also known as the effective interest
rate (EIR), annual equivalent rate (AER), or effective rate. Compare it to
the Annual Percentage Rate (APR) which is based on simple interest.
THE FORMULA FOR EFFECTIVE
INTEREST RATE IS

where:
i = Nominal interest rate
n = Number of periods 
EXAMPLE #1: 
• Antonio, who wants to identify better investment for his $50,000 for 5
years: Investment E paying APR of 10.6% compounded semiannually and
Investment F with effective interest rate of 11% compounded monthly.
 Solution: 
Effective annual interest rate = (1 + 10.60%/2)2 – 1 
= 10.88%
Antonio should choose Investment F paying 11% effective rate instead of
Investment E paying 10.6% annual percentage rate (APR) compounded
semiannually.
EXAMPLE #2:
• Consider these two offers: Investment A pays 10% interest, compounded monthly.
Investment B pays 10.1% compounded semi-annually. Which is the better offer?
Solution:
For investment A, this would be: 10.47%
= (1 + (10% / 12)) ^ 12 - 1
For investment B, it would be: 10.36%
= (1 + (10.1% / 2)) ^ 2 – 1

Investment B has a higher stated nominal interest rate, but the effective annual interest rate is
lower than the effective rate for investment A. This is because Investment B compounds
fewer times over the course of the year.
 Nominal Annual Cost of
Trade Credit

Presentor:
Villarin, Jayson S.
The Coyote Company regularly buys from its suppliers on the terms 3/12, net 30
and pays within the discount period. If the Coyote Company wanted to increase its
current liabilities by waiting longer to pay its suppliers, thereby forgoing the
discounts, what would be the nominal annual cost of trade credit, assuming that the
Coyote Company decided to pay on the 30th day? When would be the worst day for
the coyote to pay its suppliers if it was considering all of the possible days to pay?
And when would be the best possible day?

discount

discount period

days outstanding
what would be the nominal annual cost of trade credit,
assuming that the Coyote Company decided to pay on the 30th
day?

NACTC = 0.030928 x 20.2778 = 0.6272

or 62.72%

= 0.030928 x 45.625 = 1.4111 or

141.11%
When would be the worst day for the coyote to pay
its suppliers if it was considering all of the possible
days to pay?

Answer: 13th day

And when would be the best possible day?

Answer: 12th day

THANK YOU SO MUCH
FOR LISTENING!!!