Chapter16. Managing Short-Term Liabilities (Financing)

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1 Chapter16 Managing Short-Term Liabilities (Financing) 1

2 Learning Outcomes Chapter 16 Describe the characteristics of the various sources of short-term credit, including Accruals trade credit bank loans commercial paper. Discuss and compute the cost (both APR and rear) of short-term credit. Describe the procedures and benefits of using accounts receivable inventory to obtain secured short-term loans. 2

3 Short-Term Credit Any liability originally scheduled for repayment within one year 3

4 Sources of Short-Term Financing Accruals Continually recurring short-term liabilities Liabilities, such as wages and taxes, that increase spontaneously with operations Accounts Payable (Trade Credit) Credit created when one firm buys on credit from another firm 4

5 Components of Trade Credit: Free versus Costly Free Trade Credit Credit received during the discount period Costly Trade Credit Credit taken in excess of free trade credit, the cost of which is equal to the discount lost 5

6 Sources of Short-Term Financing Short-Term Bank Loans Maturity typically 90 days Promissory Notes specify terms and conditions: Amount, interest rate, repayment schedule, collateral, and any other agreements. 6

7 Sources of Short-Term Financing Short-Term Bank Loans Compensating Balance (CB) of 10 to 20 percent may be required to be maintained in a checking account. Line of Credit can be arranged. Specified maximum amount of funds available 7

8 Sources of Short-Term Financing Short-Term Bank Loans Revolving Line of Credit Line of credit where funds are committed Commitment Fee Fee charged on the unused balance of a revolving credit agreement 8

9 Choosing a Bank Differences that Exist Among Banks: Willingness to assume risks Advice and counsel Loyalty to customers Specialization Maximum loan size Merchant banking Other services 9

10 Sources of Short-Term Financing Commercial Paper Unsecured short-term promissory notes issued by large, financially sound firms to raise funds 10

11 Computing the Cost of Short-Term Credit 11

12 Computing the Cost of Bank Loans Simple Interest Loan Both the amount borrowed and the interest charged on that amount are paid at the maturity of the loan Face Value The amount of the loan (the amount borrowed) 12

13 Computing the Cost of Bank Loans Discount Interest Loan: A loan in which the interest, which is calculated on the amount borrowed (principal), is paid at the beginning of the loan period Interest is paid in advance 13

14 Computing the Cost of Bank Loans Installment Loans: Add-on Interest Interest that is calculated and then added to the amount borrowed to obtain the total dollar amount to be paid back in equal installments 14

15 Computing the Annual Cost of Bank Loans Borrowed Amount versus Required Amount 15

16 Use of Security in Short-Term Financing Secured Loans: A loan backed by collateral For short-term loans, the collateral is often either inventory or receivables Uniform Commercial Code: A system of standards that simplifies procedures for establishing loan security 16

17 Accounts Receivable Financing Pledging Receivables Using accounts receivable as collateral for a loan Recourse The lender can seek payment from the borrowing firm when receivables accounts used to secure a loan are not collectible. Factoring The outright sale of receivables 17

18 Evaluation of Receivables Financing Advantages Flexibility Can be used as security for loans that otherwise would not be granted Factoring can provide services of a credit department that would otherwise cost more. Disadvantages Administrative costs may be excessive. Some trade creditors may refuse to sell on credit to a firm that factors or pledges its receivables. 18

19 Inventory Financing Blanket Liens Trust Receipts Warehouse Receipts Acceptable Products Cost of Financing 19

20 Evaluation of Inventory Financing Advantages Amount of funds is flexible. Field warehousing increases the acceptability of inventories as loan collateral. Often results in improved warehousing practices Disadvantages Paperwork Physical separation requirements Fixed-cost element 20