Short-Term Financing

MBA – 704 :Financial Management

Prepared by: Dinard Abad Queen Fatima Valencia

Romeo Sarenas Jr Allan Oliver Villanueva
Ross Toding

Professor: Marjorie Anne Baladad

 Topic Outline
Spontaneous
Financing

Negotiated
Financing

Factoring Accounts
Receivables

Composition of
Short-Term
Financing
 Types of Spontaneous Financing

Accounts Payable Accrued Expenses

(Trade Credit from Suppliers)
Trade Credit Examples

Open Notes Trade

Accounts Payable Acceptances
 Terms of Sale

1 2 3 4

COD and CBD – Net Period – Net Period – Seasonal

No Trade Credit No Cash Discount Cash Discount Dating
 Trade Credit Means of Financing
What happens to accounts
payable if a firm purchases PHP PHP 10,000 x 30 days =
10,000 worth of goods a day from PHP 300,000 account balance
its supplier on terms of “net 30”?

What happens to accounts

payable if a firm purchases PHP PHP 15,000 x 30 days =
15,000 worth of goods a day from PHP 450,000 account balance
its supplier on terms of “net 30”?

A PHP 150,000 increase from operations

 Payment on the Final Due Date
Cost to Forgo a Discount

What is the approximate annual cost to forgo the cash

discount of “2/10”, net 30” and pay at the end of the
credit period

Approximate annual interest cost =

% discount 365 days

X
(100% - % discount) (payment date – discount period)
 Payment on the Final Due Date
Cost to Forgo a Discount

What is the approximate annual cost to forgo the cash

discount of “2/10”, net 30” and pay at the end of the
credit period

Approximate annual interest cost =

2% 365 days 2 365

X = X
(100% - 2%) (30 days – 10 days) 98 20
= 0.0204 X 18.25 = 0.3723 or 37.23%
 Payment on the Final Due Date
Cost to Forgo a Discount

The approximate interest cost over a variety

of payment decisions for “2/10, net __________.”

Payment Date* Annual Rate of Interest

11 744.9%
20 75.5%
30 37.2%
60 14.9%
90 *days from invoice date 9.3%
S-T-R-E-T-C-H-I-N-G Accounts Payable

The possible costs of stretching

accounts payable include:

Cost of the cash discount (if any)

forgone

Late payment penalties or interest

Deterioration in credit trading

 Advantages of Trade Credit

Convenience and availability

of trade credit

Greater flexibility as a means

of financing
 Who Bears the Cost of
Funds for Trade Credit?

Supplier Buyers Both

 Accrued Expenses
Wages Interest

Taxes Dividends
What is Negotiated Financing?
 Types of Negotiated Financing

Money Market Credit Unsecured Loans

Commercial Paper Line of credit

Bankers’ Acceptances Revolving credit agreement

Transaction loan
“Stand-Alone” Commercial Paper

Commercial paper market is composed of

the dealer and direct-placement
markets.

Advantage: Cheaper than a short-term

business loan from commercial bank.

Dealers require a line of credit to ensure

that commercial paper is paid off.
 “Bank-Supported” Commercial Paper

A bank provides a
letter of credit, for a
fee, guaranteeing the
investor that the
company’s obligation
will be paid.
Bankers’ Acceptances

Used to facilitate foreign trade or the

shipment of certain marketable goods.

Liquid market provides rates similar to

commercial paper rates.
 Shor-Term Business Loans

Unsecured Secured
Loans Loans
 Unsecured Loans

One-year limit that is reviewed

prior to renewal to determine if
conditions necessitate a change.

Credit line is based on the bank’s

assessment of the creditworthiness
and credit needs of the firm

“Cleanup” provision requires the

firm to owe the bank nothing for a
period of time
 Unsecured Loans

Firm receives revolving credit by paying a

commitment fee on any unused portion
of the maximum amount of credit.

Agreements frequently extend beyond 1

year.
Revolving Credit
Agreement
 Unsecured Loans

Each request is handled as a separate

transaction by the bank, and project loan
determination is based on the cash-flow
ability of the borrower.

The loan is paid off at the completion of

the project by the firm from resulting cash
Transaction Loan
flows.
Detour: Cost of Borrowing
Detour: Cost of Borrowing

Differential from prime depends

on:

Cash Balances

Other business with

the bank

Cost of servicing the loan

 Computing Interest Rates

For example: PHP 100,000 loan at 10%

stated interest rate for 1 year.

1 Interest = PHP 100,000 X 10%

= PHP 10,000

2 Interest Rate = PHP 10,000

PHP 100,000
Collect Basis
= 10% Interest
Interest Rate =
Usable funds
Interest = Initial loan X Interest Rate
 Computing Interest Rates
For example: PHP 100,000 loan at
10% stated interest rate for 1 year.

1 Interest = PHP 100,000 X 10%

= PHP 10,000

2 Usable funds = PHP 100,000 –

PHP 10,000
Discount Basis = PHP 90,000

Interest 3 Interest Rate = PHP 10,000

Interest Rate =
Usable funds PHP 90,000
Usable funds = Initial loan - Interest
= 11.11%
 Compensating Balances
For example: PHP 100,000 loan at 10% stated
interest rate for 1 year with required PHP 15,
000 compensating balances

1 Interest = PHP 100,000 X 10%

= PHP 10,000

2 Usable funds = PHP 100,000 –

PHP 15,000
= PHP 85,000
Interest
Interest Rate =
3 Interest Rate = PHP 10,000 Usable funds
PHP 85,000 Usable funds = Initial loan –
Compensating balances
= 11.76%
 Commitment Fees

Commitment Fees = Unused credit X commitment fee rate

 Commitment Fees

For example: PHP 1 million revolving credit at 10%

stated interest rate for 1 year; borrowing for the year was
PHP 600,000; a required 5% compensating balance on
borrowed funds; and a .5% commitment fee on PHP
400,000 of unused credit.

What is the cost of borrowing?

 Commitment Fees
Solution:
1 Interest: (PHP 600,000 x 10%) = PHP 60,000
2 Commitment Fee: (PHP 400,000 x 0.5%) = PHP 2,000
3 Compensating Balance: (PHP 600,000 x 5%) = PHP 30,000

4 Usable Funds: (PHP 600,000 – PHP 30,000) = PHP 570,000

5 PHP 60,000 in interest +

PHP 2,000 in commitment fees
= 10.87%
PHP 570,000 in usable funds
 Effective Annual Rate of Interest

E A R
Effective Annual Rate

%
EAR =
( Total interest paid + total fees paid
Usable funds ) X( 365 Days
# of days loan is outstanding )
(
Total interest paid = Initial loan X Interest rate X # of days loan is outstanding
365 Days )
 Effective Annual Rate of Interest

For example: Assume the same loan on the previous

example except that the loan is for 270 days and the 10%
rate is on an annual basis.

What is the Estimated Annual Rate?

 Effective Annual Rate of Interest
Solution:
1 Total interest paid = (PHP 600,000 X 10%) X (270/365) = PHP 44,384

2 Total fees paid = (PHP 400,000 x (0.5%) = PHP 2,000

3 Compensating Balance: (PHP 600,000 x 5%) = PHP 30,000

4 Usable Funds: (PHP 600,000 – PHP 30,000) = PHP 570,000

5 (
EAR =
PHP 44,384 + PHP 2,000
PHP 570,000 )X ( 365 days
270 days )
=
( PHP 46,384
PHP 570,000 )X 1.3519 = 0.0814 X 1.3519 = 0.11 or 11%
 Question

Two firms each seek a $100,000, three-month, short-term

loan from the same financial institution. One firm walks
away with an unsecured loan, and the other leaves with a
secured loan.

Which firm’s loan is probably more

expensive?
 Secured (Asset-Based) Loans

Collateral value depends on:

Marketability Riskiness

Security (collateral)

Life
 Uniform Commercial Code
Article 9 of the Code deals with:

Security interest of the lender

Security agreement (device)

Filing of the security agreement

Accounts-Receivable-Backed Loans

Loans evaluations are made on:

LOAN

Quality

Size
Types of Receivable Loan Arrangements

Non-notification Notification
 Inventory-Backed Loans

Loans evaluations are made on:

Marketability

Perishability

Price stability
Difficulty and expense of selling
for loan satisfaction
Cash-flow ability
Types of Inventory-Backed Loans

Floating Chattel Trust Terminal Field Warehouse

Lien Mortgage Receipt Warehouse Receipt
Receipt
Factoring Accounts Receivables

Cash

Factor Company
Accounts Receivable
 Factoring Cost
Factor receives a commission on the face
value of the receivables (typically <1% but
as much as 3%)

Cash Cash payment is usually made on the actual

or average due date of the receivables

If the factor advances money to firm, then

Factor Company the firm must pay interest on the advance.
Accounts Receivable
Total cost of factoring is composed of a
factoring fee plus an interest charge on any
cash advance.
Although expensive, it provides the firm
with substantial flexibility.
Composition of Short-Term Financing
Cost of the financing Degree to which the
method Timing assets are encumbered

Availability of Flexibility
funds
Thank you!