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    Short Term Financing

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    Hyeree Abdullah
    This document discusses short term financing sources available to firms. It describes spontaneous/internal financing sources like accounts payable and accrued expenses. It also discusses non-spontaneous or external financing sources such as secured short term loans using accounts receivable or inventory as collateral, and unsecured loans including lines of credit, commercial paper, and factors that determine their effective costs.

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    Attribution Non-Commercial (BY-NC)
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    Short Term Financing

    Uploaded by

    Hyeree Abdullah
    324 views30 pages
    This document discusses short term financing sources available to firms. It describes spontaneous/internal financing sources like accounts payable and accrued expenses. It also discusses non-spontaneous or external financing sources such as secured short term loans using accounts receivable or inventory as collateral, and unsecured loans including lines of credit, commercial paper, and factors that determine their effective costs.

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    This document discusses short term financing sources available to firms. It describes spontaneous/internal financing sources like accounts payable and accrued expenses. It also discusses non-spontaneous or external financing sources such as secured short term loans using accounts receivable or inventory as collateral, and unsecured loans including lines of credit, commercial paper, and factors that determine their effective costs.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    324 views30 pages

    Short Term Financing

    Uploaded by

    Hyeree Abdullah
    This document discusses short term financing sources available to firms. It describes spontaneous/internal financing sources like accounts payable and accrued expenses. It also discusses non-spontaneous or external financing sources such as secured short term loans using accounts receivable or inventory as collateral, and unsecured loans including lines of credit, commercial paper, and factors that determine their effective costs.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    of 30

    CHAPTER 8

    SHORT TERM FINANCING

    Introduction
    Def : ST funds that a firm has to repay within a year of obtaining these fund
    Sources

    NonSpontaneous Financing Secured Short Term Loans Unsecured short-term loan

    Spontaneous / Internal Financing Accounts Payable Accrued Taxes and Wages

    Spontaneous/Internal Financing
    Def : Financing that arise from the normal operation of the firm Sources ; A/C payable and Accrued Taxes and

    Wages Account Payable Transaction in which the firm bough goods on credit from its suppliers and no formal is signed
    Cost of not utilizing the cash discount (AOC)

    = Discount % 360 days___________ (100% - Disc%) X (credit period discount period)

    Example
    Lawrence Industries operation of a small chain of video stores purchased 1,000 worth of merchandise on Feb 28 from a supplier

    extending term of 2/10, net 30.

    Non-Spontaneous/External Financing
    Secured Short Term Loans
    A loan whereby the borrowers need to provide a

    security or collateral

    Unsecured Short Term Loans


    Loans granted by banks without any collateral Sources of unsecured financing are : Notes payable Line of credit Revolving credit Commercial Paper

    Cost of Bank Loans


    Nominal Interest Rate
    Effective Annual I/R Discounted Loan
    I/R unadjusted for inflation or term of borrowing The actual cost of borrowings after taking into

    considerations of differential in period of compounding and terms associated with borrowings


    of the loan period.

    Interest on loan is paid in advance or at the beginning

    Compensating Balances
    Deposit that the firm keeps with the bank in a low-

    interest or non-interest bearing to compensate for bank loans or services

    Unsecured Short Term Loans


    Line of Credit An informal arrangement between a bank and its customer specifying the maximum amount of unsecured credit that the bank will permit the firm to owe at any one time. Interest on loan ; collect basis and discount basis

    Cont.
    Collect Basis Interest is paid at maturity Formula; EIR = Interest paid X 360 days Principal t Where; t = days loan is outstanding

    Cont.
    Discount basis Interest is paid in advance / prepaid Formula ; EIR = Interest paid X 360 days Net proceeds t Where ; t = days loan is outstanding Net proceeds = Loan amount interest paid

    Example
    Mr Lee is going to borrow RM3,000 for one year at 12% interest. What is the effective rate if the loan is :

    a) Collect basis b) Discount basis

    Answer
    a) Collect basis

    EIR = Interest paid X 360 days Principal t = 12% (3,000) X 360 days 3,000 360 days = 12%

    Cont.
    b) Discount basis EIR = Interest paid X 360 days Net proceeds t = 12%(3,000) X 360 days 3,000 360 360 days = 13.64%

    Compensating Balance
    A required deposit that the firm keeps with the bank

    in low interest to compensate for bank loans Calculated as a percentage of the borrower loans outstanding Formula : EIR = Interest paid X 360 days Net proceeds t Where; Net proceed = Loan amount compensating amount

    Example
    Suppose you borrow RM20,000 at 14% interest rate per annum paid at maturity and the compensating balance requirement is

    10%. What will the effective cost of the loan ?

    Answer
    EIR = Interest paid X 360 days

    Net proceeds t = 20,000 (14%) X 360 days 20,000 (10% x 20,000) 360 days = 15.56%

    Example
    You borrow RM25,000 at 15% interest rate per annum and the compensating requirement is 10%. What is the effective

    interest rate of loan if the interest is prepaid ?

    Answer
    EIR = Interest paid X 360 days

    Net proceeds t EIR = 15% X 25,000 X 360 days 25,000 (0.1x25k) (.15 x 25k) 360 days = 20%

    Revolving Credit Agreement


    A formal and legally binding commitment to give line

    of credit to the borrower up to stated amount agreed The borrower pay interest on the used loan and commitment fee on the unused portion of the credit line Formula : EIR = Interest + Commitment fee X 360 days Usable Fund t Where; t = days loan is outstanding Usable funds = amount loan borrowed compensating balance

    Example
    Binariang Corporation has a revolving agreement with a bank. It can borrow up to RM2,000,000 at 12% interest but is required

    to maintain a 10% compensating balance on any funds borrowed under the agreement. In addition, it must pay a 0.5% commitment fee on the unused portion of the formal line. What is the EIR of taking a loan, if the firm utilizes RM800,000 for an entire year.

    Answer
    EIR = Interest + Commitment fee X 360 days Usable Fund t Interest = 12% x RM800K = RM96,000 Compensating balance = 10% x RM800k = RM80,000 Usable funds = RM800,000 RM80,000 = RM720K Commitment fee = 0.5% X (2mill RM800K) = RM6k
    EIR = 96,000 + 6,000 X 360 days 720,000 360 days = 14.16%

    Commercial Paper
    A short term unsecured promissory note that is generally sold by large corporation on a discount basis to institutional investors and

    other corporation It is preferred due to several factors:


    Interest rate is lower than bank loans The issuing house does not require any

    compensating balance Widely recognized and usually issued by the most creditworthy firm

    Cont.
    Formula:
    EIR = Interest X 360 days Face value interest issuing cost Maturity

    Example
    On May 2008, Motorola Corporation plan a

    commercial paper issue of RM30m. The firm has never used commercial paper before but has decided to go through a dealer to handle the process. The commercial paper will carry 270-day maturity and will require interest based upon a rate of 11% per annum. In addition, the firm will have to pay fees totaling RM200,000 for going through the dealer. What is the effective cost of the commercial paper issue to Motorola Corporation?

    Answer
    EIR = Interest X 360 days Face value interest issuing cost Maturity Interest = 11% x 30mill = 3.3mill x 270 360 = RM2,475,000 EIR = 2,475,000 X 360 30m 2,475k 200k 270 = 12.07%

    Secured Short Term Loans


    Short term loan obtained by pledging specific assets as collateral Characteristics;
    Lenders require collateral typically current assets Only a certain percentage of book value of acceptable

    collateral is advance by the lenders More expensive Increase the administration cost

    Collaterals;
    Inventory financing Account receivable financing

    Account receivable financing


    Use accounts receivable as collateral to obtain a loan from other financial institution either through pledging or factoring

    receivables

    Inventory Financing
    Use inventory as short term loan collateral
    Characteristic of inventories that can be

    evaluated as loan collateral


    Marketable
    Not perishable Price stability

    Cont.
    4 ways inventory financing can occur
    Floating lien agreement The lenders receive a security interest or general claim on the firms entire inventory that include present and future inventory

    Trust receipts The firm holds the inventory for the lender and any proceeds from the inventory must immediately forward to the lenders
    Terminal warehouse receipts The inventory forwarded as collateral will be stored in a bonded warehouse operated by a public warehousing company Field warehouse receipts Same procedure as terminal warehouse except the inventory is stored in the firm is own warehouse

    Tutorial
    April 2008 Q4
    Apr 2007 Q5

    THANK YOU

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