Finance Module 5 Sources of Short Term Funds

Business Finance
Governor Pack Road, Baguio City, Philippines 2600

Tel. Nos.: (+6374) 442-3316, 442-8220; 444-2786;
442-2564; 442-8219; 442-8256; Fax No.: 442-6268 Grade Level/Section: Grade 12- ABM
Email: [email protected]; Website: www.uc-bcf.edu.ph
MODULE 5 – FINANCE Subject Teacher: Kenny Jones A. Amlos
Sources and uses of Short term FUNDS

Learning objectives:
At the end of this module, students must be able to:
1. explain basic problems encountered in managing short-term funds;
2. determine the factors in selecting sources of short-term funds;
3. identify the various sources of short-term funds;
4. solve problems involving short-term funds;
5. make a simple recommendation to the management.
CONTENTS:
SHORT-TERM FINANCING:
Short-term financial management (Working Capital Management) is the management of cash
inflows and cash outflows that occur within one year. This involves managing the entity’s investment
in current assets and the Sources of funding together with the associated Costs involve in each
possible source of financing.
Types of Short-term financing source:

a. Secured credit – borrowed funds backed up by collateral or by a pledged asset.
b. Unsecured credit – financing granted without any specific asset used as collateral and approval
is merely based on trust and confidence by the lender on the character of the borrower.
Sources, uses, and costs of SHORT-TERM funds:

1. Accrual of expenses – Zero cost, since no interest is involved in accrual of expenses.
No cost of financing to the company as long as no penalties are imposed on delaying the
payments of an operating expense.
Recommendation: maximize the negative float (delay the outflow) at its maximum. Utilize the
available cash to the fullest possible period to earn revenue for the company.
2. Suppliers’ trade credit

𝑫% 𝟑𝟔𝟎
Annual nominal cost of trade credit 𝑨𝑵𝑪 = 𝟏𝟎𝟎%−𝑫%
𝒙 𝑭𝑫−𝑫𝑷
Where:
𝐴𝑁𝐶 = 𝐴𝑛𝑛𝑢𝑎𝑙 𝑛𝑜𝑚𝑖𝑛𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑡𝑟𝑎𝑑𝑒 𝑐𝑟𝑒𝑑𝑖𝑡
𝐷% = 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑖𝑛 𝑝𝑒𝑟𝑐𝑒𝑛𝑡
𝐹𝐷 = 𝐹𝑖𝑛𝑎𝑙 𝑑𝑢𝑒 𝑑𝑎𝑡𝑒 (𝐶𝑟𝑒𝑑𝑖𝑡 𝑃𝑒𝑟𝑖𝑜𝑑)
𝐷𝑃 = 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑝𝑒𝑟𝑖𝑜𝑑
Note: to convert the nominal cost or rate into its effective annual rate (EAR), use this formula:
𝐷% 𝑛 360
𝐸𝐴𝑅 = (1 + 100%−𝐷%) − 1 note: 𝑛 =
𝐹𝐷−𝐷𝑃
Nominal or stated rate is the interest rate expressly agreed (written or verbal) upon by the
debtor and creditor.
Effective or implicit rate is the actual interest rate in the transaction after considering other
factors such as time.
Sample problem no. 1:

An entity is given a trade credit terms of 2/10, net 30. If the entity failed to take the discount,
what is the cost to the firm?
Solution:
𝟐% 𝟑𝟔𝟎
𝑨𝑵𝑪 = 𝒙
𝟏𝟎𝟎% − 𝟐% 𝟑𝟎 − 𝟏𝟎
Business Finance Page 1 of 4
Business Finance
Tel. Nos.: (+6374) 442-3316, 442-8220; 444-2786;
= 36.7%
Recommendation: If the available cash of the company can be utilized to generate a return
higher than 36.7%, it is advisable to use the money first and just pay the account on its due
date.
3. Bank loans
𝑰 𝟑𝟔𝟎
a) Simple Interest (not discounted) rate: 𝑬𝑨𝑹 = 𝒙
𝑷 𝑪𝑷
Where:
𝐼 = 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑃 = 𝑃𝑟𝑖𝑛𝑐𝑖𝑝𝑎𝑙 𝐶𝑃 = 𝐶𝑟𝑒𝑑𝑖𝑡 𝑝𝑒𝑟𝑖𝑜𝑑

You are contemplating to borrow ₱10,000 from BD-Ow bank which offers to lend you the
money at a 10% nominal or stated rate on a 180-day loan. What is the effective interest rate if
the loan is a simple loan?
Solution:
₱𝟏, 𝟎𝟎𝟎 𝟑𝟔𝟎
𝑬𝑨𝑹 = 𝒙
₱𝟏𝟎, 𝟎𝟎𝟎 𝟏𝟖𝟎
= 20%
Recommendation: If the company can use the money on an investment that will earn a return
higher than 20%, accept the offer of the bank and invest the money.
𝑰 𝟑𝟔𝟎
b) Discounted interest rate: 𝑬𝑨𝑹 = 𝒙
𝑷−𝑰 𝑪𝑷
Where:
𝐼 = 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑃 = 𝑃𝑟𝑖𝑛𝑐𝑖𝑝𝑎𝑙 𝐶𝑃 = 𝐶𝑟𝑒𝑑𝑖𝑡 𝑝𝑒𝑟𝑖𝑜𝑑

money at a 10% nominal or stated rate on a 180-day loan. What is the effective interest rate if
the loan is a discount loan?
Solution:
₱𝟏, 𝟎𝟎𝟎 𝟑𝟔𝟎
𝑬𝑨𝑹 = 𝒙
₱𝟏𝟎, 𝟎𝟎𝟎 − ₱𝟏, 𝟎𝟎𝟎 𝟏𝟖𝟎
= 22.22%
higher than 22.22%, accept the offer of the bank and invest the money.
Note: The effective rate is higher because there’s an advanced interest taken and proceeds
of the loan will be lesser as compared to simple interest.
𝟐 𝒙 𝑵𝒐. 𝒐𝒇 𝑷𝒂𝒚𝒎𝒆𝒏𝒕 𝒙 𝑰
c) Add-on interest rate 𝑨𝑨𝑹 =
𝟏+ 𝑵𝒐. 𝒐𝒇 𝑷𝒂𝒚𝒎𝒆𝒏𝒕 𝒙 𝑷
Where:
𝐼 = 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡
𝑃 = 𝑃𝑟𝑖𝑛𝑐𝑖𝑝𝑎𝑙
Note: to convert the AAR into its effective annual rate (EAR), use the PV Table or use
interpolation.

Business Finance
Tel. Nos.: (+6374) 442-3316, 442-8220; 444-2786;
money at a 12% add-on interest rate on a 180-day loan payable every 30 days. What is the
effective interest rate of the loan?
Solution:
𝟐 𝒙 𝟔 𝒙 ₱𝟏, 𝟐𝟎𝟎
𝑨𝑨𝑹 =
𝟏 + 𝟔 𝒙 ₱𝟏𝟎, 𝟎𝟎𝟎
= 20.57%
𝑰 𝟑𝟔𝟎
d) Interest rate with compensating balance: 𝑬𝑨𝑹 = 𝒙
𝑷−𝑰−𝑪𝑩 𝑪𝑷
Where:
𝐼 = Interest
𝑃 = 𝑃𝑟𝑖𝑛𝑐𝑖𝑝𝑎𝑙
𝐶𝐵 = 𝐶𝑜𝑚𝑝𝑒𝑛𝑠𝑎𝑡𝑖𝑛𝑔 𝐵𝑎𝑙𝑎𝑛𝑐𝑒 (𝑎𝑚𝑜𝑢𝑛𝑡 𝑡𝑜 𝑏𝑒 𝑟𝑒𝑡𝑎𝑖𝑛𝑒𝑑 𝑖𝑛 𝑡ℎ𝑒 𝑏𝑎𝑛𝑘 𝑡𝑜 𝑙𝑒𝑠𝑠𝑒𝑛 𝑡ℎ𝑒 𝑟𝑖𝑠𝑘 𝑜𝑓 𝑐𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛)
𝐶𝑃 = 𝐶𝑟𝑒𝑑𝑖𝑡 𝑝𝑒𝑟𝑖𝑜𝑑

money at a 10% nominal or stated rate on a 180-day loan. As a condition of the loan, the
entity is required to maintain a compensating balance of ₱300 in its checking account. What
is the effective interest rate if the loan is a discount loan?
Solution:
₱𝟏, 𝟎𝟎𝟎 𝟑𝟔𝟎
𝑬𝑨𝑹 = 𝒙
₱𝟏𝟎, 𝟎𝟎𝟎 − ₱𝟏, 𝟎𝟎𝟎 − ₱𝟑𝟎𝟎 𝟏𝟖𝟎
= 22.99%
𝑰+𝑰𝑪 𝟑𝟔𝟎
4. Commercial papers 𝑬𝑨𝑹 = 𝒙
𝑭𝑽−𝑰−𝑰𝑪 𝑫𝑴
Where:
𝐸𝐴𝑅 = 𝐸𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝐴𝑛𝑛𝑢𝑎𝑙 𝑅𝑎𝑡𝑒
𝐼 = 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 (𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡)
𝐼𝐶 = 𝐼𝑠𝑠𝑢𝑒 𝐶𝑜𝑠𝑡 𝑜𝑟 𝐹𝑙𝑜𝑎𝑡𝑎𝑡𝑖𝑜𝑛 𝐶𝑜𝑠𝑡
𝐹𝑉 = 𝐹𝑎𝑐𝑒 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑡ℎ𝑒 𝑛𝑜𝑡𝑒𝑠 𝑜𝑟 𝑐𝑜𝑚𝑚𝑒𝑟𝑐𝑖𝑎𝑙 𝑝𝑎𝑝𝑒𝑟𝑠
𝐷𝑀 = 𝐷𝑎𝑦𝑠 𝑡𝑜 𝑚𝑎𝑡𝑢𝑟𝑖𝑡𝑦

ABV Co. is contemplating to issue ₱100,000 commercial papers at a discount rate of 12% for
300 days. Floating the commercial paper in the money market will cost ₱1,500. What is the
effective interest rate of the commercial paper?
Solution:
₱𝟏𝟐, 𝟎𝟎𝟎 + ₱𝟏, 𝟓𝟎𝟎 𝟑𝟔𝟎
𝑬𝑨𝑹 = 𝒙
₱𝟏𝟎𝟎, 𝟎𝟎𝟎 − ₱𝟏𝟐, 𝟎𝟎𝟎 − ₱𝟏, 𝟓𝟎𝟎 𝟑𝟎𝟎
= 18.73%
higher than 18.73%, proceed with issuance of the commercial paper and invest the money.

Business Finance
Tel. Nos.: (+6374) 442-3316, 442-8220; 444-2786;
𝑰+𝑶𝑪 𝟑𝟔𝟎
5. Pledging and factoring of receivables 𝑬𝑨𝑹 = 𝒙
𝑵𝑷 𝑫𝑴
Where:
𝐸𝐴𝑅 = 𝐸𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝐴𝑛𝑛𝑢𝑎𝑙 𝑅𝑎𝑡𝑒
𝐼 = 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡
𝑂𝐶 = 𝑂𝑡ℎ𝑒𝑟 𝑐ℎ𝑎𝑟𝑔𝑒𝑠 𝑙𝑖𝑘𝑒 𝑓𝑎𝑐𝑡𝑜𝑟𝑖𝑛𝑔 𝑓𝑒𝑒
𝐷𝑀 = 𝐷𝑎𝑦𝑠 𝑡𝑜 𝑚𝑎𝑡𝑢𝑟𝑖𝑡𝑦
𝑁𝑃 = 𝑁𝑒𝑡 𝑃𝑟𝑜𝑐𝑒𝑒𝑑𝑠
Note: Account receivable is a source of fund because it can be sold either thru pledging of
factoring, to interested investors who are willing to take the risk of collection.

AR Co. has a ₱100,000 outstanding accounts receivable that is due within 40 days. The
company has an urgent need of cash. A factor offered 2.5% discount plus factor fee of ₱500.
Should AR Co. accept the offer if the net proceeds will be re-invested to earn a return on 25%?
Solution:
₱𝟐, 𝟓𝟎𝟎 + ₱𝟓𝟎𝟎 𝟑𝟔𝟎
𝑬𝑨𝑹 = 𝒙
₱𝟏𝟎𝟎, 𝟎𝟎𝟎 − ₱𝟐, 𝟓𝟎𝟎 + ₱𝟓𝟎𝟎 𝟒𝟎
= 27.84%
Recommendation: NO. The cost is higher that the benefit. If the company can use the
proceeds on an investment that will earn a return higher than 27.84%, then the company may
accept the offer of the factor. Furthermore, it will be much better if the risk of collection is
totally transferred to the factor like in the case of factoring without recourse.
References:
✓ BAL 658.15 C1128, 2017. Cabrera, Ma. Elenita Balatbat and Cabrera, Gilbert Anthony B.,
Business Finance for Senior High School, GIC Enterprises
✓ BAL 658.15 G4476, 2017. Gitman, Lawrence J., et. al. Business Finance. JO-ES Publishing House,
Inc.
✓ BAL 332.4 L161, 2015. Laman, Rose Marie B. et. al. Financial System, Market & Management.
GIC Enterprises
✓ BAL 658.15 An15, 2010. Anastacio, Ma. Flordeliza, Dacanay, Roberto C. Fundamentals of
Financial Management, Rex Book Store

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Business Finance

Governor Pack Road, Baguio City, Philippines 2600

MODULE 5 – FINANCE Subject Teacher: Kenny Jones A. Amlos

Sources and uses of Short term FUNDS

Types of Short-term financing source:

Sources, uses, and costs of SHORT-TERM funds:

2. Suppliers’ trade credit

Sample problem no. 1:

MODULE 5 – FINANCE Subject Teacher: Kenny Jones A. Amlos

Sample problem no. 2:

Sample problem no. 3:

Sample problem no. 4:

Business Finance Page 2 of 4

MODULE 5 – FINANCE Subject Teacher: Kenny Jones A. Amlos

Sample problem no. 5:

Sample problem no. 6:

Business Finance Page 3 of 4

MODULE 5 – FINANCE Subject Teacher: Kenny Jones A. Amlos

Sample problem no. 7:

Business Finance Page 4 of 4

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