Short-Term Financing
MBA – 704 :
Financial Management
Prepared by:
Dinard Abad
Romeo Sarenas Jr
Ross Toding
Professor:
Marjorie Anne Baladad
Queen Fatima Valencia
Allan Oliver Villanueva
Topic Outline
Spontaneous
Financing
Negotiated
Financing
Factoring Accounts
Receivables
Composition of
Short-Term
Financing
Types of Spontaneous Financing
Accounts Payable
(Trade Credit from Suppliers)
Accrued Expenses
Trade Credit Examples
Open
Accounts
Notes
Trade
Payable Acceptances
Terms of Sale
1
2
3
4
COD and CBD –
No Trade Credit
Net Period –
No Cash Discount
Net Period –
Cash Discount
Seasonal
Dating
Trade Credit Means of Financing
What happens to accounts payable
if a firm purchases PHP 10,000
worth of goods a day from its
supplier on terms of “net 30”?
PHP 10,000 x 30 days =
PHP 300,000 account balance
What happens to accounts payable
if a firm purchases PHP 15,000
worth of goods a day from its
supplier on terms of “net 30”?
PHP 15,000 x 30 days =
PHP 450,000 account balance
A PHP 150,000 increase from operations
Payment on the Final Due Date
Cost to Forgo a Discount
What is the approximate annual cost to forgo the cash
discount of “2/10”, net 30” and pay at the end of the
credit period
Approximate annual interest cost =
% discount
(100% - % discount)
X
365 days
(payment date – discount period)
Payment on the Final Due Date
Cost to Forgo a Discount
What is the approximate annual cost to forgo the cash
discount of “2/10”, net 30” and pay at the end of the
credit period
Approximate annual interest cost =
2%
(100% - 2%)
X
365 days
(30 days – 10 days)
= 0.0204 X 18.25
=
2
98
= 0.3723 or 37.23%
X
365
20
Payment on the Final Due Date
Cost to Forgo a Discount
The approximate interest cost over a variety
of payment decisions for “2/10, net __________.”
Payment Date*
Annual Rate of Interest
11
20
30
60
90
744.9%
75.5%
37.2%
14.9%
9.3%
*days from invoice date
S-T-R-E-T-C-H-I-N-G Accounts Payable
The possible costs of stretching
accounts payable include:
Cost of the cash discount (if any)
forgone
Late payment penalties or interest
Deterioration in credit trading
Advantages of Trade Credit
Convenience and availability
of trade credit
Greater flexibility as a means
of financing
Who Bears the Cost of
Funds for Trade Credit?
Supplier
Buyers
Both
Accrued Expenses
Wages
Interest
Taxes
Dividends
What is Negotiated Financing?
Types of Negotiated Financing
Money Market Credit
Unsecured Loans
Commercial Paper
Line of credit
Bankers’ Acceptances
Revolving credit agreement
Transaction loan
“Stand-Alone” Commercial Paper
Commercial paper market is composed of
the dealer and direct-placement
markets.
Advantage: Cheaper than a short-term
business loan from commercial bank.
Dealers require a line of credit to ensure
that commercial paper is paid off.
“Bank-Supported” Commercial Paper
A bank provides a
letter of credit, for a
fee, guaranteeing the
investor
that
the
company’s obligation
will be paid.
Bankers’ Acceptances
Used to facilitate foreign trade or the
shipment of certain marketable goods.
Liquid market provides rates similar to
commercial paper rates.
Short-Term Business Loans
Unsecured
Loans
Secured
Loans
Unsecured Loans
One-year limit that is reviewed
prior to renewal to determine if
conditions necessitate a change.
Credit line is based on the bank’s
assessment of the creditworthiness
and credit needs of the firm
“Cleanup” provision requires the
firm to owe the bank nothing for a
period of time
Unsecured Loans
Firm receives revolving credit by paying a
commitment fee on any unused portion
of the maximum amount of credit.
Revolving Credit
Agreement
Agreements frequently extend beyond 1
year.
Unsecured Loans
Each request is handled as a separate
transaction by the bank, and project loan
determination is based on the cash-flow
ability of the borrower.
The loan is paid off at the completion of
the project by the firm from resulting cash
flows.
Transaction Loan
Detour: Cost of Borrowing
Detour: Cost of Borrowing
Differential from prime depends
on:
Cash Balances
Other business with
the bank
Cost of servicing the loan
Computing Interest Rates
For example: PHP 100,000 loan at 10%
stated interest rate for 1 year.
1
Interest = PHP 100,000 X 10%
= PHP 10,000
2
Interest Rate = PHP 10,000
PHP 100,000
= 10%
Collect Basis
Interest
Interest Rate =
Usable funds
Interest = Initial loan X Interest Rate
Computing Interest Rates
For example: PHP 100,000 loan at
10% stated interest rate for 1 year.
1
Interest = PHP 100,000 X 10%
= PHP 10,000
2
Discount Basis
Interest
Interest Rate =
Usable funds
Usable funds = Initial loan - Interest
Usable funds = PHP 100,000 –
PHP 10,000
= PHP 90,000
3
Interest Rate = PHP 10,000
PHP 90,000
= 11.11%
Compensating Balances
For example: PHP 100,000 loan at 10%
stated interest rate for 1 year with required
PHP 15, 000 compensating balances
1
Interest = PHP 100,000 X 10%
= PHP 10,000
2
Usable funds = PHP 100,000 –
PHP 15,000
= PHP 85,000
3
Interest Rate = PHP 10,000
PHP 85,000
= 11.76%
Interest
Interest Rate =
Usable funds
Usable funds = Initial loan –
Compensating balances
Commitment Fees
Commitment Fees = Unused credit X commitment fee rate
Commitment Fees
For example: PHP 1 million revolving credit at 10%
stated interest rate for 1 year; borrowing for the year was
PHP 600,000; a required 5% compensating balance on
borrowed funds; and a .5% commitment fee on PHP
400,000 of unused credit.
What is the cost of borrowing?
Commitment Fees
Solution:
1
Interest:
(PHP 600,000 x 10%)
= PHP 60,000
2
Commitment Fee:
(PHP 400,000 x 0.5%)
= PHP 2,000
3
Compensating Balance: (PHP 600,000 x 5%)
4
Usable Funds:
5
= PHP 30,000
(PHP 600,000 – PHP 30,000) = PHP 570,000
PHP 60,000 in interest +
PHP 2,000 in commitment fees
PHP 570,000 in usable funds
= 10.87%
Effective Annual Rate of Interest
E
A
R
Effective
Annual
Rate
%
(
EAR =
) X(
(
Total interest paid + total fees paid
Usable funds
Total interest paid = Initial loan X Interest rate X
365 Days
# of days loan is outstanding
)
)
# of days loan is outstanding
365 Days
Effective Annual Rate of Interest
For example: Assume the same loan on the previous
example except that the loan is for 270 days and the 10%
rate is on an annual basis.
What is the Estimated Annual Rate?
Effective Annual Rate of Interest
Solution:
1 Total interest paid = (PHP 600,000 X 10%) X (270/365) = PHP 44,384
2 Total fees paid =
3 Compensating Balance:
4 Usable Funds:
5
(
(
EAR =
=
(PHP 600,000 x 5%)
(PHP 600,000 – PHP 30,000)
PHP 44,384 + PHP 2,000
PHP 570,000
PHP 46,384
PHP 570,000
= PHP 2,000
(PHP 400,000 x (0.5%)
)X
) X(
= PHP 30,000
= PHP 570,000
)
365 days
270 days
1.3519 = 0.0814 X 1.3519 = 0.11 or 11%
Question
Two firms each seek a $100,000, three-month, short-term
loan from the same financial institution. One firm walks
away with an unsecured loan, and the other leaves with a
secured loan.
Which firm’s loan is probably more
expensive?
Secured (Asset-Based) Loans
Collateral value depends on:
Marketability
Riskiness
Security (collateral)
Life
Uniform Commercial Code
Article 9 of the Code deals with:
Security interest of the lender
Security agreement (device)
Filing of the security agreement
Accounts-Receivable-Backed Loans
LOAN
Loans evaluations are made on:
Quality
Size
Types of Receivable Loan Arrangements
Non-notification
Notification
Inventory-Backed Loans
Loans evaluations are made on:
Marketability
Perishability
Price stability
Difficulty and expense of selling
for loan satisfaction
Cash-flow ability
Types of Inventory-Backed Loans
Floating
Lien
Chattel
Mortgage
Trust
Receipt
Terminal
Warehouse
Receipt
Field Warehouse
Receipt
Factoring Accounts Receivables
Cash
Factor
Company
Accounts Receivable
Factoring Cost
Factor receives a commission on the face
value of the receivables (typically <1% but
as much as 3%)
Cash payment is usually made on the actual
or average due date of the receivables
Cash
Factor
Company
Accounts Receivable
If the factor advances money to firm, then
the firm must pay interest on the advance.
Total cost of factoring is composed of a
factoring fee plus an interest charge on any
cash advance.
Although expensive, it provides the firm with
substantial flexibility.
Composition of Short-Term Financing
Cost of the financing
method
Availability of
funds
Timing
Degree to which the
assets are encumbered
Flexibility
Thank you!