Chapter16
Managing Short-Term
Liabilities (Financing)
1
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
Short-Term Credit
Any liability originally scheduled for
repayment within one year
3
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
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
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
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
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
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
Sources of Short-Term Financing
Commercial Paper
 Unsecured short-term promissory notes issued by
large, financially sound firms to raise funds
10
Computing the Cost of Short-Term Credit
11
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
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
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
Computing the Annual Cost of Bank Loans
Borrowed Amount versus Required Amount
15
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
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
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
Inventory Financing
Blanket Liens
Trust Receipts
Warehouse Receipts
Acceptable Products
Cost of Financing
19
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