Order
Placed
Order
Received
< Inventory >
Sale
Payment Sent Cash
Received
Accounts
Collection
< Receivable > < Float >
Time ==>
Accounts
< Payable >
Invoice Received
Disbursement
<
Float
>
Payment Sent
Cash
Disbursed
 Formulate
 Choose
a short-term financing strategy.
the appropriate financing instrument.
 Compute
the effective cost of financing.
A
deficit cash position may result from the
interaction of inefficient or inappropriate
working capital policies
 Management should first evaluate its working
capital policies to ensure the most efficient
stream of cash flow from operations
 Once this is done, then a short-term financing
strategy should be developed
Total Assets
$
Temporary Current Assets
Permanent Current Assets
Fixed Assets
Time
 Aggressive
Financing Strategy- financing
the new current assets with liabilities
having comparable maturities
 Management relies heavily on short-term financing and
minimizes long-term financing
 Net Working Capital position and Current ratios are
reduced, impairing solvency
 Beneficial when short term financing is cheaper than
long term sources
 Exposes to refinancing risk as credit me tighter in future
periods and interest rate risk during inflation
$
Short-Term Financing
Total Assets
Long-Term
Financing
Time
 Conservative
Financing Strategy- use the
long term sources of financing to meet
working capital requirements
 Improve solvency as current assets will be higher than
current liabilities
 Expensive because long term sources are more costly
than short term sources.
 Reduced refinancing and interest rate risk.
Excess Liquidity
$
Long-Term
Financing
Time
 Moderate
Financing Strategy- combination
of both aggressive and conservative
strategies.
Excess
Liquidity
Short-Term
Financing
$
Long-Term
Financing
Time



Lines of Credit: Maximum loan amount a lender is willing to
provide to a client upon demand.
• Borrower can use line whenever they choose, avoiding
the loan application process
Committed line of credit: formal, written agreement that
binds the lender to provide a maximum funds at the
borrower’s bequest
• Such agreement requires a commitment fee to pay
• Typically have covenants to ensure that the borrower
maintains a certain level of financial health
Uncommitted Line of Credit: not a binding obligation for the
lender
• Lenders like the flexibility offered by uncommitted lines,
which free the bank from providing funds in the event of
financial deterioration by the borrower.
 Direct
Costs
• Interest rate: applied on amounts drawn from the line
• Commitment fee: only relevant for committed lines and is
a stated proportion of the unused portion of the line.
 Indirect
Costs
• Compensating Balance: restricts fund availability; reduces
net loan proceeds and increasing the effective cost of line.

Banker’s Acceptance – Is a time draft drawn against a
commercial bank but with payment at maturity guaranteed by the
bank.
:
 Letter of credit a promise to a party upon presentation of a
draft or bill, provided that the party complies with certain
documentary requirements as stated in the agreement between
the bank and customer.
 Standby letter of Credit : Which guarantees that the bank will
make funds available if the company cannot or does not wish to
meet a major financial obligation.
 Reverse Repurchase agreement : is the other side of
repurchase agreement transaction where the corporate manager
may negotiate with its bank to sell the bank a specific dollar
amount of marketable securities.
 Commercial
paper is a short term
promissory note issued by a corporation
for fixed maturity at a fixed discount rate.
• Discount basis commercial paper
• Interest bearing commercial paper
Out of pocket
Expenses
365
Effective rate = -------------------- x ------Usable funds
M
(16.1)

Out of pocket costs
• Interest expense
• Commitment fee
• Dealer fee

Usable funds
• Discounted price (Face value less interest)

Out of pocket costs
• Interest expense
• Commitment fee

Usable funds
• Net proceed after keeping the compensating
balance
Short-term financing alternatives in this
chapter differ from spontaneous financing
sources such as payables and accruals.
 The chapter began with a discussion of
financing three financing strategies.
 Then discussion focused on the major forms
of short-term financing available.
 The chapter concluded with a discussion of
calculating the effective cost of financing with
commercial paper and credit lines.
