Short-Term

Financing
Chapter 8
Learning Objectives:
At the end of the chapter, students are expected to be able to:
• Identify the different sources of short-term financing;
• Explain the advantages and disadvantages of short-term financing;
• Compute the cost benefits of the firm; and
• Apply short-term financing to make a sound decision.
 CURRENT LIABILITIES
Short-term financing, as presented in the balance sheet, consist of all current liabilities. The
revised Philippine Accounting Standards No. 1 provides the following criteria for the liability to be
considered as current:
• It is expected to be settled in the entity’s normal operating cycle.
• It is held primarily for the purpose of being traded.
• It is due to be settled within 12 months after the balance sheet date.
• The entity does not have an unconditional right to defer settlement off the liability for at least
12 months after the balance sheet date.
Current liabilities are numerous and range from the time spontaneous accounts payable are
recognized on trade credit and interest is accrued up to the time the debts are obtained. These
current liabilities are part of the working capital used by the firm within its normal operating cycle.
However, there are other current liabilities which are not settled as part of the normal operating
cycle but are due for settlement within 12 months after the balance sheet date. Examples are
financial liabilities held for trading, bank overdraft, dividends payable, and current portion of non-
current financial liabilities.
ADVANTAGE OF SHORT-TERM FINANCING
1. It is easier to arrange.
2. It is less expensive.
3. It affords the borrower more flexibility.
DISADVANATGE OF SHORT-TERM FINANCING
4. Interest rate fluctuates more often.
5. Refinancing is frequently needed.
6. Delinquent payment may be detrimental to the credit rating of the
borrower that is already experiencing a liquidity problem.
SOURCES OF SHORT-TERM FINANCING
1. Trade credit
2. Stretching of payables
3. Accruals
4. Short-term bank loans
5. Banker’s acceptances
6. Commercial finance company loans
7. Commercial papers
8. Receivable financing
9. Inventory financing
 TRADE CREDIT
• Trade credit is an agreement between two parties; the buyer and the seller. The buyer
receives the invoice sent by the seller specifying the goods purchased, the purchased
price, the total amount to be paid, and the terms of purchase (Brigman & Houston, 2011)
• The term of purchase is the cheapest way of obtaining a short-term loan and is
considered to be the largest source of short-term funds. The term offered may or may
not consist of a discount. Thus, if the buyer made the payment within the discount period
allowed by the seller, the buyer gets the cash discount. Otherwise, the buyer must pay
the whole amount at the end of the credit period. For instance, a credit term of 2/10, n/30
means paying the goods within 10 days from the invoice date gives the buyer a discount
of 2%. However, if no payment is received within 10 days, the buyer must pay the full
amount on the 30th day.
To compute for the average accounts payable, the formula is:
=
The formula for the cost discount forgone is:
=
Example:
ABC Corporation has an annual purchase of P1,500,000. The term offered by the supplier was
2/10, n/30. The company did not avail of the discount but always pays on time at the end of
the credit period. How much is the balance of accounts payable of ABC Corporation? What is
the cost of discount foregone? 
Answer:
Accounts payable =

=
= P125,000
Cost of discount forgone =
= 36.73%
Another way of computing for the cost of discount forgone is:

=
=
=
= 36.73%
Example:
ABC Corporation considers availing of the discount on the credit term offered
by the supplier. The terms are 4/10, n/60. At the time the term is offered, the
borrowing rate in the market is 12% per annum. Should ABC Corporation take
advantage of the discount period?
The analysis would be as follows:
Cost of discount forgone =
= 30%
ABC Company should avail of the cash discount because the cost of borrowing
is 12% which is less than the cost of discount forgone. Thus the firm will be
better off by borrowing at a rate of 12% and then paying the supplier. The net
advantage of the firm in availing of the discount is 18% (30%-12%).
FACTORS CONSIDERED IN TRADE CREDIT
Offering trade credit depends on many factors. The most common are as
follows:
1. Market Condition.
2. Financial Stability.
3. Competitiveness.
4. Nature of the product.
5. Nature of the demand and supply.
 
 STRETCHING PAYABLE

Stretching payables means paying the obligations later than expected (Van
Horne, 2002). This form of short-term financing helps the company reduce the
cost of discounts. For instance, if the seller gave a credit term of 1/10, n/30, the
cost of discount will be:
Cost of discount forgone =
= 18.18%
However, if the company will not pay on the 3oth and instead will prolong the
payment until the 45th day, the cost of forgone will become:
Cost of discount forgone =
= 10.39%
The example shows that prolonging the payment of
obligations can determine how the cost of discount
foregone will decline. This kind of strategy may help in the
short run, but if it becomes a regular practice, a firm will
run the risk of losing the trust of its supplies.
In addition, the credit rating of the firm will drop. With the
reduction of the firm's credibility to pay on time due to the
stretching of payables, suppliers will be fed up and may no
longer be willing to sell on credit.
 ACCRUALS
Accruals are the expenses already incurred but not yet paid off by the company. Some of
these expenses are salaries and wages, taxes, and interest.
Salaries and wages are compensation given to employees. However, they are not paid and
accumulate for some time. With the discrepancy, the company is able to benefit from Short-
term financing. The company has the power to use the funds for other operating activities
until such time that it needs to release the salaries and wages. For example, the company
has 100 employees who earn P250 a day and the payment of which takes place after 15 days.
In this case, the company is able to obtain a spontaneous short-term financing amounting to
P375,000 (100 x P250 x 15 days) from accrued salaries and wages.
Taxes also accrue to the company. There are taxes which are paid monthly, quarterly, semi-
annually, and annually. The payment dates are set by the Bureau of Internal Revenue (BIR).
Regardless of the scheme tax payment, the company buys some time to use its money for
other activities before the final settlement of taxes.
Accrued interest payment is another source of short-term financing. The firm enters into an
agreement with a financial institution to pay interests on its borrowings. The interest
accrues every day but the payment of the interest will take place only upon reaching the
agreed time of payment. The delay of interest payment also provides a short-term fund for
the company.
Example:
FLT Corporation obtained a 60-day short-term loan amounting to P1,000,000. The interest charge is 12%
per annum. The loan was released on March 1, 2012 and will mature on April 30, 2012. The interest should
be paid at the end of the term.
How much accrued interest did FLT Corporation have, as a form of short-term financing, on the following
dates?
1. March 15, 2012
2. March 30, 2012
3. April 15, 2012
Answer:
Using the formula I = Prt, the answer is as follows:
1. March 15, 2012 = P1,000,000 x 0.12 x 15/360 = P5,0000
2. March 30, 2012 = P1,000,000 x 0.12 x 30/360 = P10,0000
3. April 15, 2012 = P1,000,000 x 0.12 x 45/360 = P15,0000
In the given example, FLT Corporation was able to obtain a short-term loan on interest amounting to
P5,000, P 10,000, and 15,000 on March 15, 30, and April 15, 2012, respectively. Instead of paying the
interest on the mentioned dates, the firm has the advantage of using these funds. However, on April 30,
2012, the firm is obliged the pay the principal plus the interest for 60 days amounting to t 1,020,000
 SHORT-TERM BANK LOANS
These are loans secured from banks which are payable in one year. Banks obtain their money
from current, and time deposits, and other special forms of accounts. They lend this money to
individuals, companies, or government agencies. As a sign of indebtedness, banks ask
companies to sign a promissory note. This document serves as proof that the company has an
obligation to pay the bank for the principal and interest when the term matures. The loans
obtained from the bank are paid off on the maturity' dates or by installment. Interest, on the
other hand, is collected either in advance or at the end of the term.
There are several reasons why a company borrows money on short-term. Some of them are
as follows:
1. To cover for the prices of the goods purchased
2. To take advantage of the cash discount offered by the seller
3. To cover for the operating activities of the company
4. To cover for the down payment in the acquisition of fixed assets
5. To reserve cash for the unexpected activities of the company
6. To meet cash dividend payments
Before the bank grants loan to the firm, it assesses the company for sufficient equity and
good liquidity. Firms seeking a loan are assessed based on the five C' Of credit (character,
capital, capacity, conditions, and collateral).
Before the loan approval, the account officer will lay out all the conditions given by the
bank before the release of such a loan. Some of them are as follows:
1. Companies are asked to deposit a compensating balance; that is, they are required by
lending banks to maintain a minimum balance at low-cost account like current or savings
account.
2. The rate given is based on the prime rate, the London interbank offered rate (LIBOR),
an additional rate above the prime or LIBOR, or a rate which the bank thinks as
reasonable.
3. The loan may be given as a lump sum or on a piecemeal basis depending on the
approving officer. The reason for it is that the approving officer may still be wary of the
company's performance and would like to protect the bank's best interest.
4. Collaterals to be offered by the company, if any
5. The amount of the loan to be given
FACTORS IN CHOOSING THE BANK
1. The firm must know the bank's line of expertise. Some banks are highly
specialized in a field which is not related to the company's line of operations.
Knowing the business is a big factor in identifying the most efficient way of
utilizing cash management, investment in marketable securities, control of
receivables, inventories, and other financial matters. Banks that know the
business well will save the company a lot of time and money.
2. The loyalty of the bank regarding its willingness to stand by its borrowing
customers through difficult time must be checked.
3. The company should choose a bank capable of handling the firm's borrowing
requirements and depository transactions, service charges, compensating
balance requirements, and interest rates.
4. A bank whose interest rate is highly competitive with other banks is preferable.
TYPES OF BANK FINANCING
The company can choose among the several types of financing offered by the bank. The bank
financing may take any of the following forms:
1. Unsecured loans - In banking terms, an unsecured loan is a clean loan. These are loans not
backed up by any form of collateral.
2. Secured loans - If the firm does not qualify for an unsecured loan, it can apply for a secured
loan. One of the reasons why a bank insists on a secured loan is that the company has not yet
established a good relationship with the bank. The firm may have a good financial standing and
efficient cash flow but the bank is not that confident to take a business risk. Collaterals acceptable
to the bank are real estate located in a prime area; chattel mortgage in the form of equipment,
machines, vehicles; blue chip stocks; receivables; and inventory.
3. Credit line - This is a type of loan granted by banks to a firm on a periodic basis, normally for one
year, and up to a specific amount. If the borrowing firm has established a good credit standing with
the bank, the credit line can be renewed after a year. The loan under this facility is given in lump
sum or on a piecemeal basis, provided that this will not exceed the amount of loan granted.
4. Installment loans. These are loans that are paid in a time/period series—monthly, quarterly, or
semi-annually. The payment consists of principal plus the interest. In making payments, the bank
may use either the straight-line method or the scientific method.
1. Straight-line method. This is a method with fixed principal payment every periodic payment. It is
computed by dividing the principal by the number of periods. Added to the principal payment is the interest
payment which is computed based on the outstanding balance.
Example: On January 1, 2012, RCBC credited the account of Phoenix Corporation for the amount of ?
120,000. The principal is payable in 4 equal quarterly payments plus interest based on the outstanding
balance. An amortization table shows the principal and interest payments. Assume that the interest rate is
12% per annum and that the payment starts on April 1.
Date Principal Payment Interest Payment Total Payment Outstanding Balance

01/01/12 P120,000
04/01/12 P30,000 P3,600 P33,600 90,000
07/01/12 30,000 2,700 32,700 60,000
10/01/12 30,000 1,800 31,800 30,000
01/01/13 30,000 900 30,900 0

Since the condition is for equal quarterly payment on the principal, then the principal payment shall be
P30,000 with interest computed as P3,600 (P 120,000 x 0.12 x 90/360). The table above shows an equal
payment of principal plus the interest to arrive at the total payment. The first total payment of P33,600 is
obtained by adding the principal of and the interest of P3,600.
Another way of computing for the total monthly payments is by adding the interest for one year on the
principal amount of loan and dividing the total number of payments in a year. This procedure will be
discussed further in computing for the effective rate with an add-on interest.
2. Scientific method. This is a method in which the total payment per period is equal. The principal payment is
obtained by deducting the interest from the total payment. To compute for the total payment, the following
formula is applied using the present value of annuity of 1.
Total Loan = Periodic Payment
Example: Using the information on the Phoenix Corporation, the total payment may be solved as:
Let x = Periodic payment
P120,000 = x
P120,000 = x (3.717)
X = P120,000/3.717
X = P32,284
Thus, the total quarterly payment on the principal and the interest is P32,284. The amortization table using the
scientific method will be:
Phoenix Corporation
Amortization Table
Date Principal Payment Interest Payment Total Payment Outstanding Balance
01/01/12       P120,000
04/01/12 P28,684 P3,600 P32,284 91,316
07/01/12 29,545 2,739 32,284 61,771
10/01/12 30,431 1,853 32,284 31,340
01/01/13 31,340 940 32,280 0.00

The total payment per period is equal to P32,284 as computed using the present value of an annuity of 1. By
computing the interest based on the outstanding balance and deducting the same from the total payment, the
principal payment is obtained. With this type of loan payment, the principal payment increases and the interest
diminishes as the maturity dates approach.
 COMPENSATING BALANCE
As mentioned earlier, compensating balance is the minimum balance of the firm’s current or savings
account required by lending banks. There are two types of compensating balance:
1. Activities related to the account holder’s account.
2. Activities related to bank credits.
COMPENSATING BALANCE ON ACCOUNT HOLDER’S ACCOUNT
This concerns the balances maintained in the accounts of the depositors (Kolb & Demong, 1988). An
example is the auto-debit transfer account. It is an account where payments are made through checks
but the funding is from the savings account. A computerized system automatically debits the savings
account every time a check is issued by the account holder. There are two separate account numbers for
the current and savings accounts, but the account number of the current account is automatically
captured and the system is directed to charge the check to the savings account. With this type of
service, the bank charges a higher fee than the normal maintaining balance of the current account or
savings account because of the use of customized system. If the current account and the savings
account have a maintaining balance of P10,000 each, then the auto-debit transfer account will have a
maintaining balance of P25,000.
Here, the compensating balance is not a loan-related. Rather, a balance is reserved for the maintaining
balance and service required of the accounts. Instead of charging fees specific to the services rendered,
the bank would rather offset it through the compensating balance.
 COMPENSATING BALANCE ON BANK CREDITS
This is a compensating balance directly associated with the loan activities of the customer.
Typically, the compensating balance, as expressed in an average daily balance, ranges from 10% to
20% of the loan and depends on the credit standing of the company. For instance, if the company
borrows P500,000 and the bank requires a compensating balance of 10%, then the firms account
should maintain an average of daily balance of P50,000.
Banks require a compensating balance for three reasons. The first is to increase the effective
interest rate earned by the bank from the loan lent to the company. At present, compensating
balance vary greatly that banks have the option to stipulate maintaining an average daily balance
on both the unused and used portions or only on the used portion of the credit. Second, banks
normally do not charge firms on miscellaneous expenses for the other services offered to the
clients. To offset such, a compensating balance is required. The third and last reason for requiring a
maintaining balance is for safety; that is, in case of a default is incurred by the company in paying
its obligation, the bank can immediately debit the account of the company.
To compute for the amount to be loaned that requires a compensating balance, the formula is:
Amount to be borrowed =
Where: c = compensating balance
 INTEREST RATES
The interest rate is the amount charged to the borrowing
company for the use of funds of the bank. Interest rate on
short-term loans vary depending on the amount of the loan,
the intensity of competition among banks, the financial
capability of the firm, and the reason for borrowing. Interest
rates charged to valued customers are normally less than
those charged to clients who have not yet established a good
relationship with the bank. The interest rate also differs in
countries that are not politically and economically stable.
 Methods of Interest Charging
1. Add-on interest. The interest is computed based on the outstanding loan balance, and
whatever interest computed is added to the principal payment.
Example: Assume a loan of P150,000 that has an add-on interest of 12% for 90 days. Compute for
the interest due and the total payment required on the 90th day. Use 360 days in a year.
Answer:
Interest = Principal x Rate x Time
= P150,000 x 0.12 x 90/360
= P4,500
On the maturity date, the total payment will be:
= Principal + Interest
= P150,000 + P4,500
= P154,500
The payment on the face value of the loan is increased by the amount of the interest.
2. Discounted interest. The interest computed is immediately deducted from the principal
amount of the loan. When pre-payment on interest is made, the proceeds from the loan are
reduced and the effective interest rate is increased. Here, the borrower receives money lower than
the face value of the loan.
Example: Assume a loan of P150,000 with a discount rate of 12% for 90 days. Compute for the
interest and discounted amount of the loan. Using 360 days in a year, how much should be paid on
the 90th day?
Interest = Principal x Rate x Time
= P150,000 x 0.12 x 90/360
= P4,500
The discounted amount is:
= Principal - Interest
= P150,000 - P4,500
= P145,500
The loan payment on the 90th day will be P150,000 (P145,500 + P4,500).
 Cost of Commercial Bank Financing
The Cost of commercial bank financing is measured in terms of the effective
interest rate. This is the actual rate charged by banks or other lending institutions
on the borrower. The effective interest rate is computed using the following
variables:
1. Interest amount
2. Interest rate
3. Days loan outstanding
4. Method of interest charge
5. Type of loan
 Effective Rate on Add-on Interest
Getting the effective rate with an add-on interest is the most basic
computation in calculating loans and charging interest. It is simple
enough since a loan with an interest amounting to P15,000 per annum
on a P150,000 loan for a year will have an effective rate of 10%.
However, this is only true if the loan is good for a year. What if the
P15,000 interest carries a 90-day loan? What will be its effective rate?
In this case, the formula will be:
Effective rate = x
=x
= 40%
 Effective Rate on Discounted Interest
If the discounted loan is to be applied in getting the effective interest rate, the
above formula will still be used except that the interest is deducted immediately
from the principal. Using the same example, the effective interest rate would be:
Effective rate = x
= x
= 44.44%
It must be noted that the effective interest rate on a discounted loan is higher than
that of the loan using an add-on interest. The reason is that the principal, which is
the base for computing the rate, has a smaller amount.
 Effective Rate with Compensating Balance
As previously mentioned, the formula to compute for the loan to be borrowed is
the amount needed/ (1 - c). The same concept will be applied in this case, except
that the numerator this time is the interest rate. Loans with a required
compensating balance increases the effective rate of the loan. Example: Assume
that a company is charged 9% on its loan for one year with a compensating
balance of 15%. What is the effective rate with the compensating balance?
Effective rate =
=
= 10.59%
Another way of computing for the effective rate with compensating balance is:
Effective rate = x
Where c = compensating balance
Example: Connelly Corporation is paying P100 interest for 120 days on a P1,000 loan with
a compensating balance of 10%. How much is the effective rate?
Answer:
Effective Rate = x
= 33.33%
The above example assumes that the interest is an add-on. In case the loan is a
discounted loan, the interest amount will be included in the denominator as a deduction.
Thus, applying the effective interest rate on a discounted loan with a compensating
balance, the computation will result in 37.50% (P100/(P1,000 - P100 - P100) x 360/120).
 Effective Rate on Installment Loan
As mentioned earlier, an installment loan is an obligation where principal payments are made in
series. Financial institutions normally charge interest on an add-on basis. To compute for the
effective interest rate, the formula is:
=
Example: Concon borrowed P15,000 on a 12-month installment basis with total monthly payments
applicable to interest and principal. The interest rate charged by the lending institution is 12% per
annum. Thus, the interest will be P1,800 for one year. Since this is an add-on interest, then the total
payment will have a face value of P16,800 for one year with a monthly payment of P1,400(P16,800/12).
The interest has been computed in advance and added to the principal in order to arrive at the monthly
payment. The principal amount of loan could have been used for only a month but the interest
computation is based on the principal amount of loan and not on the diminishing balance. A P1,400
payment per month inclusive of interest and principal, and without actually using the P15,000 for one
year, gives an approximate outstanding loan balance of only P7,500. Thus, the effective interest rate will
be:

=
= 22.15%
 Banker’s Acceptance
Banker’s acceptance are mainly used for transactions to finance the shipment and
handling of merchandise between an exporter and an importer. Banker’s
acceptance is a type of short-term financing in the sense that they mature in less
than a year, normally less than 180 days. This kind of security entails a small
amount of risk because of the backing made by the importer’s bank. As an
example, consider a Philippine company entering into an agreement with the
American company for the letter to grant credit for 80 days from the shipment
date. Once the credit is granted, the American company, to be assured that it will
be paid, asks the Philippine company to apply for a letter of credit authorizing it to
draw a 90-days draft from the importer’s bank. The Philippine company, conceit
satisfied its own bank, says RCBC then issues the letter of credit addressed to the
American company authorizing it to draw a draft payable in 90 days amounting to
100,000.
 Commercial Finance Company Loans
At times, when credit is unavailable from banks, a company
in dire financial straits has to go to order financing or lending
institutions. Because of the risky nature of the company,
financing or lending institutions charge interest higher than
those of commercial banks. Collaterals like accounts
receivable, inventory, or fixed assets are sometimes attached
for security reasons.
 Commercial Papers
A type of short-term financing, a commercial paper is issued with an unsecured
promissory note. Only companies possessing the highest credit ratings can issue
commercial papers (Brealy, Myers, & Marcus, 2017). The interest cost incurred by
the firm in the issuance of commercial papers fluctuates with supply and demand
conditions. Commercial papers are sold at a discount in the form of short-term
promissory notes and have a maturity date that varies from one to nine months.
Commercial papers are also rated. The higher the credit rating, the lower the
interest rate charged. Firms and other financial institutions normally see
commercial papers profitable investments for their excess cash rather than
placing it in government treasury bills. With yields higher than government
securities, commercial papers are becoming more and more popular with
industrial firms, mutual fund managers, and private individuals as a wise
investment for their hard-earned money.
Example:
Conan Corporation, having a high credit rating, is given an opportunity to issue a
commercial paper worth 100,000 at 15% for 120 days. The funds obtained from
the issuance will be needed for 90 days only. The excess funds on hand can be
invested in securities with a rate of return equivalent to 12%. The brokerage fee of
the marketable security transactions is 2%. What is the cost of issuing the
commercial paper?
Answer:
Interest Expense (P100,000 x 0.15 x 120/360) P5,000
Add: Brokerage Fee (P100,000 x 0.02) 2,000
Total Cost P7,000
Less: Return on marketable securities
(P100,000 x 0.12 x 30/360) 1,000
Net Cost P6,000
 Receivable Financing
During an economic slump where various markets suffer from the crunch, firms have
difficulty collecting receivable on credits sales on time. With minimal cash available to run
their operations, they resort to borrowing. Since banks also face the same situation, most
often, they require companies to offer collateral to back up the firm's loan application. As
an alternative, accounts receivable may be offered as collateral.
Receivable financing allows the company an elbow room to raise money out of its current
receivable. The most common forms of receivable financing are:
a. Pledging of accounts receivable
b. Assignment of accounts receivable
c. factoring of accounts receivable
d. Discounting of promissory notes
A. Pledging of Accounts Receivable
Pledging of accounts receivable is a process of using receivables as loan
collateral. This pledging is done through a non-notification basis, which
means the firm's customers are not informed that their account or their
obligation to the company is attached as collateral.
B. Assignment of Accounts Receivable
Assignment of accounts receivable is a process in which the borrower
(assignor) assign the accounts receivable to the creditor (assignee) as
collateral on the loan. Assignment is executed by signing a security
agreement transferring receivables to the creditor. It may be in the form of
a non-notification or notification basis. Like pledging, the assignor retains
ownership over the accounts receivable; thus, the assignor pays the
assignee in case the collections are not enough to cover the amount loaned.
EXAMPLE:
C. Factoring of Accounts Receivable
Under this form of financing, there is an outright sale of accounts receivable to
the bank or financing company ( called a factor). In a factoring arrangement, a
company sells its accounts receivable on a without recourse basis. Without
recourse means the financing company assumes the full responsibility of
collecting the accounts receivable and in the event of non-collection, the financing
company can no longer collect from the seller company.
D. Discounting of Promissory Notes –
A promissory note is an unconditional promise in writing to pay on demand, or at a future date, a
definite sum of money. The note may specify a maturity date or indicate if the amount is payable
on demand. A promissory note is a negotiable financial paper; it can be sold to a bank or lending
agency at a specified discount rate. It is either interest-bearing, or non-interest-bearing. An
interest-bearing note includes the face value plus the interest. If the note is non-interest-bearing
the maturity value is the same as the face value.
The important features of a promissory note are the following:
1. Face value. It is the amount of loan to be paid on maturity date.
2. Date of note. It refers to the date in which the note is written.
3. Maturity date. It specifies the date of payment as agreed by the borrower an d lender.
4. Interest rate. It is the cost of borrowing.
5. Creditor. It indicates the one who accepts the promissory note and to whom payment will be
made.
6. Debtor. It identifies the borrower who signs the promissory note.
EXAMPLE:
 Inventory Financing
Inventory financing happens when a firm has nothing to offer as
collateral for a loan. Inventory as collaterals requires consideration of
marketability, perishability, and market price stability to give
assurance that such inventory could be liquidated in an amount
sufficient to recover the loan in case of non-payment the merchandise
should not be subject to rapid obsolescence.
Types of Inventory Financing
1. Floating lien. Also known as blanket lien, it is a type of inventory financing where the
creditor has a claim on the inventory as a whole without specifying the kind of inventory
being attached.
2. Warehouse receipt. Under this agreement, good are specified, segregated, and stored
in a public or terminal warehousing company. The Debtor, who secures the warehouse,
instructs the warehouse keeper to issue a warehouse receipt to the creditor signifying
that the inventories attached as collateral have been delivered and under their custody.
EXAMPLE:
Roval Corporation wants to finance its P200,000 inventory. Funds are needed for 60 days.
A warehouse receipt loan may be taken at 12% with a 70% advance in the inventory’s
value. The warehouse is P9,500 for the 60-day period. How much is the cost of financing
the inventory?
Interest (P200,000 x 0.12 x 0.70 x 60/360) = P2,800
Warehousing cost = 9,500
Total Cost = P12,300
3. Trust receipt. Under this scheme of inventory financing,
although the title to the inventory is retained by the creditor,
debtor is authorized by the former to use the inventory for
production or selling, provided that whatever proceeds from
the use of the inventory entrusted to the debtor will be
remitted immediately.
End of Discussion.