Medium-term or Intermediate Term Financing

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1 Medium-term or Intermediate Term Financing Medium term finance [loan] is usually provided from three to ten years; Such finance is Obtained for meeting the cost of maintenance, repair, improvement and betterment of plant i.e., expansion and modernization of the existing plant; and Used for purchase of assets, costly raw material, and to repay the short term loans. Medium term finance is specially useful for small capital projects or the developing new projects.

2 Features of medium-term loans Time/maturity - more than one year but less than five years, although sometimes may be extended to even 10 years; in Bangladesh it is usually from 3 to 7 years. Purpose Used for acquiring working capital, sometimes for purchase of equipment and machines, and expansion of buildings or creation of additional facilities Security required in almost all cases and the usually fixed assets (buildings, plants, machines) are used as security, although stocks (shares and debentures) are also taken as security. Recycling/renewal mid-term loan arrangements are mostly renewable; commercial banks practice revolving credit to provide mid-term loans. Size and nature of the firm all firms, small, medium or large collect finance from medium-term sources. However, the loan size is usually not very large.

3 Sources of medium-term or intermediate term financing Medium term loans: banks, insurance companies, development banks, finance agencies, equipment manufacturers, leasing companies, public fixed deposit, pension and provident funds. Forms: revolving credit, deferred credit, lease financing, working capital term loans, conditional sales contract and mortgage including financing by mortgaging equipment, chattel mortgage trust receipt loan, warehouse receipt loan

4 Commercial banks Provide medium term finance to traders and manufacturers against security and applying fixed interest rate (the same rate of interest for the whole period of loan) or variable interest rate (interest rate changed within the loan period based on changes in the bank rate of prime rate i.e. the current market rate following any major change in he money and capital market). Commercial banks provide term loans as well as revolving credit. Commercial banks raise funds by collecting deposits from businesses and consumers via checkable deposits, savings deposits, and time (or term) deposits and make loans to businesses (for establishment of new businesses, expansion of product line, plant modernization, working capital financing) and consumers. They also buy corporate bonds and government bonds. Deposits are the primary liabilities of commercial banks and loans and bonds are their primary assets. Commercial banks provide loans of two types: secured loan unsecured loan.

5 Revolving credit Type of credit extended under agreement between lending organization (usually, a commercial bank) and the borrower on extending credit in amounts within a pre-aproved limit and the amount (within the limit) may be repeatedly used with availability of fund which may increase or decrease (within the limit) as funds are borrowed and repaid. There is no fixed number of payments as it is the case in installment credit. Examples of revolving credits used by consumers include credit cards. Corporate revolving credit facilities are typically used to provide liquidity for a company's day-to-day operations. In a revolving credit arrangement The borrower makes payments based only on the amount they've actually used or withdrawn, plus interest. The borrower may repay over time (subject to any minimum payment requirement), or in full at any time. In some cases, the borrower is required to pay a fee to the lender for any money that is undrawn on the revolver; this is especially true of corporate bank loan revolving credit facilities.

6 Mortgage Transfer of an interest in property to a lender as a security for a debt on the condition that this interest will be returned to the owner when the terms of the mortgage have been satisfied or performed. Mortgage loans however, are now more institutional and belong to secured loans as it is used as a very common type of debt instrument in purchase of real estate. Use the property as security in the form of lien on the title to the property until the mortgage is paid off in full. If the borrower defaults on the loan, the bank would have the legal right to repossess the property and sell it, to recover sums owing to it.

7 Financing by mortgaging equipment: Chattel Mortgage and Conditional Sales Contract Chattel mortgage - Loan arrangements allowing persons/businesses to purchase movable property (the chattel) from the lender, who secures the loan with a mortgage over the chattel. In this case movable personal property is used as the security for the loan, rather than the more common approach of using the actual real estate to secure the loan. In choosing to use movable property as the chattel for the loan, the borrower keeps possession of the property but allows the lender to exercise a lien against the asset or assets that will remain in effect for the duration of the loan. Once the chattel mortgage is repaid in full, the borrower reassumes full control of the chattel. A key factor in the structure for a chattel mortgage is that the assets held as security cannot be permanently tied to any land holdings owned by the borrower. This means that such assets as buildings, or even land that does not currently support any type of building structure, cannot be used as the collateral or chattel for the financial arrangement.

8 Trust Receipt Loan Known alterantively as floor pallnning is an arrangement under which a company mortgages assets with a bank from which the company takes loan aginst the assets but (a) continues to hold, use and even enjoy the right to sell the assets with the condition that (b) the income earned from commercial use of the asset or from its sale will be used on priority basis in repaying the loan. Thus, in an arrangement involving a trust receipt, the bank remains the owner of the mortgaged assets sold by the borrower of the bank s loan, but the buyer is allowed to hold the asset in trust for the bank, for manufacturing or sales purposes.

9 Warehouse Receipt Loan Loan against warehouse receipt, a document giving proof of ownership of goods held in inventory, for example, unfinished goods temporarily stored in a field warehouse by a manufacturer. Warehouse receipt is a document listing goods or commodities kept for safekeeping in a warehouse. The receipt is a title document for its holder and may be either negotiable or nonnegotiable. Most warehouse receipts are issued in negotiable form, making them eligible as collateral for working capital loans from a bank. The receipt can also be used to transfer ownership of that commodity, instead of having to deliver the physical commodity. Warehouse receipts are used with many commodities, particularly precious metals like gold, silver, and platinum, which must be safeguarded against theft. Two forms of warehouse receipts are: terminal warehouse receipt list of goods or commodities kept for safekeeping in formal warehouse (government warehouse, ware house of a port, or of a warehousing company) and field warehouse receipt - list of goods or commodities kept, with a consent from a formal warehouse, in a company s own warehouse build at its own premise.

10 Conditional Sales Contract Term loan given against an agreement between the seller of equipment/machine on credit and the buying company that after purchase of the equipment/machine the company may use it but its ownership continues to remain with the seller until the full payment for the machine/equipment is made and in case the buyer fails to make the payment, the seller retains the right to take it back in its own possession. In such case, the seller receives a down payment and a promissory note (for the amount of money remaining unpaid) and can sell the promissory note as a commercial paper. The company/person discounting the note then automatically gets the right to claim ownership on the machine/equipment on lien.

11 Insurance companies Provide loan to manufacturers against the security of assets but usually, for longer period and at interest rates higher than the commercial banks. Insurance companies accumulate funds received as premium from policy holders and the idle deposits, as well as the surplus are given as loans, usually for longer periods (10 or more years) to established and relatively large companies where the risks are not high. They charge relatively lower interest rates and prefer giving loans in amounts much larger than the commercial banks usually offer. Besides longer loan period, one of the other reasons for higher interest rate is the fact that insurance companies do not require maintaining a compensating balance that the commercial banks do (commercial banks keep a certain amount, say 4% of the loan sanctioned as compensating balance, which the borrower cannot withdraw; this makes the effective rate of interest of bank loans higher than the nominal rates).

12 Development banks and specialized finance agencies Bangladesh has a number of development banks, also known as Development finance Institutions (DFI) or specialized financial institutions (SFI) for providing finance (for establishment and BMRE of firms, factories and enterprises in specialized sectors) and such institutions include Bangladesh Shilpa Bank (BSB), Bangladesh Krishi Bank (BKB), Bangladesh Shilpa Rin Sangstha (BSRS), Bangladesh Small Industries and Commerce Bank Limited (BASIC Bank), Bangladesh Small and Cottage Industries Corporation (BSCIC), Bangladesh Rural development board (BRDB), Rajshahi Krishi Unnayan Bank (RAKUB), Investment Corporation of Bangladesh (ICB), Bangladesh House Building Finance Corporation (BHBFC) and some others. Financing of industries by Bangladesh Small and Cottage Industries Corporation (BSCIC) also falls in this group.

13 Lease Financing Emerged in the recent years as one of the most important sources of medium (and also long-) term financing. Lease is a written agreement between a company (the lessor) that buys machines or even plants and then leases them out to the lessee industries and thereby provide an important financing support. Under the leasing agreements, the lessee company acquires the right to use the asset i.e., the lessor permits the lessee to economically use the asset for a specified period of time (in exchange of making periodic rental payments) but the title of the asset is retains by the lessor. At the end of the lease contract

14 Advantages of Leasing Risks of ownership: lessee can avoid the risks attached with the ownership of the equipments, say risk of obsolescence in the area of over changing technologies. Saving of capital outlay: Lessee can make full use of the asset without making immediate payments of the purchase price which otherwise would be payable by him. Tax advantages: the payment of lease rents is the tax deductible expenditure. Structuring of lease rents: Lessor may structure the payments of lease rents in such a way that it matches the revenue expectations of the lessee from the equipments, No effect on borrowing power: As the obligations accepted by the lessee under the lease deed appear nowhere on the balance sheet as debt, the borrowing power of the lessee still remains unaffected. The lessee may still resort to debt capital provided equity base of the company permits further borrowing. Convenience: Leasing is the quickest method of financing the requirements of long term capital and lessee is relieved from the rigid and time consuming procedures and terms and conditions involved in other forms of term borrowings say term loans.

15 Deferred Credit Money received in advance of it being earned i.e., income items received by a business, but not yet reported as income. An example is a consulting fee received in advance before being earned or, say, a magazine publisher might defer a 3-year subscription to match revenue against later publication expenses. A deferred credit is a deferred revenue, unearned revenue, or customer advances. A deferred credit could also result from complicated transactions where a credit amount arises, but the amount is not revenue. Deferred credit is also called deferred annuity and deferred income tax charge. The term also applies to revenue normally includable in income but deferred until earned and matched with expenses. The deferred credit is classified under noncurrent liabilities. However, it can be a current liability or a non-current depending on the specifics.

16 Public fixed deposit Fixed deposits are loan arrangements where a specific amount of funds is placed on deposit under the name of the account holder. The money placed on deposit earns a fixed rate of interest (higher than a standard savings account), according to the terms and conditions that govern the account. The actual amount of the fixed rate can be influenced by such factors at the type of currency involved in the deposit, the duration set in place for the deposit, and the location where the deposit is made.

17 Working capital term loans A short term loan known to help tide over a financial crunch which a business organization faces. Working capital loans pump in the cash flow and fund the daily operations of your business and are therfore, considered ideal for the sustaining of a business. Companies which are growing fast and furious are more prone to capital shortage and are in need of working capital despite reflecting huge amount of profits on paper. These companies need to invest more money on continuous improvements and innovations for their current set of products and also diversify into other product lines; and pay for infrastructure, advertising campaigns, marketing promotions, new machinery and also meet expenses of day to day nature like rent, bills and employee salaries.

18 Types of working capital loans Line of Credit/Overdraft: drawing funds beyond the available limit of your bank account but withiun the amount limited by the line of credit.. The interest rate is usually charged 1-2 percent over the bank's prime rate. Short-term loans: They are almost synonymous with working capital loans. Contrary to an overdraft, a short term loan has a fixed payment period which is usually for up to a year. The interest rate is also usually fixed on this form of working capital loan. Short terms loans are generally secured wherein you are granted the finance against collateral. Factoring/advances: These are loans based on confirmed sales orders or account receivables. Accounts receivable implies the amount of money that you have billed the customer but have not received the payment. If your customers are reliable and reputable, the lending company will be able to raise the working capital for you. Equity: These funds can come from your own personal resources like the home equity loan, a relative, a friend or an angel investor (third party investor with business experience relevant to your company) Trade creditor: He is a creditor who may be willing to extend terms to meet a big order.

19 The Questions Lenders Ask Before Granting Working Capital Loans Is your business capable of generating enough money to pay off the interest on the loan? What is the history of the business? How well has the business been performing for the past few years? Prove the previous stability of your company if you are looking to get a working capital loan. In case the business does not do well, how do you plan to repay the loan amount and the interest? What is the background of the managers and how dedicated are they to the business? Are they good enough to steer the business properly even when there are obstacles? How are the sales growing in terms of volume? What is the growth rate of the sales and what are the future plans of expansion as far as sales are concerned? How profitable is the business? Who are the competitors for your business? How do you plan to gear up for potential competition? Is the industry growing and mushrooming well? Is the cash flow smooth? Are you able to pay your employees on time and are you able to pay your bills promptly? Are you in a position to keep the cash momentum going on most of the time? How is your past credit history? Have you been prompt with your payments for the previous loans taken by you?

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