• Short-term financing is usually easier to obtain than long-term
– Shorter repayment period means less risk of nonpayment
– Amounts of short-term loans are smaller than long-term loans
– There is a closer relationship between borrower and lender
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• Unsecured financing
– Financing not backed by collateral
• Trade credit
– Financing extended by a seller who does not require immediate payment after the delivery of the merchandise
• Promissory notes
– A written pledge by a borrower to pay a certain sum of money to a creditor at a specified future date
– Unlike trade credit, promissory notes usually include interest
– Legally binding
– Negotiable instruments
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(cont’d)
• Unsecured bank loans
– Interest rates vary with each borrower’s credit rating
– Prime interest rate
• The lowest rate charged by a bank for a short-term loan
– Offered through promissory notes, a line or credit, or revolving credit agreement
• Commercial paper
– Short-term promissory note issued by a large corporation
– Interest rates are usually below that charged by banks for short-term loans
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Source: Federal Reserve Bank website, www.federalreserve.gov, accessed October 17, 2008.
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• Loans secured by inventory
– Inventory is pledged as collateral
– Control of the inventory passes to the lender until the loan is repaid
– The borrow must pay storage for the inventory
– Floor planning
• The title to the inventory is given to lenders in return for short-term financing
• The borrow maintains control of the inventory
• Loans secured by receivables
– Amounts owed the firm in the form of accounts receivable from trade credit given to customers are pledged as collateral
– Quality of receivables is considered
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• Another method of raising short-term financing
• Factor
– A firm that specializes in buying other firms’ accounts receivable
• The factor buys accounts receivable for less than their face value
• The factor collects the full dollar amounts when each account is due
• The factor’s profit is the difference between the face value and what it paid for the accounts receivable
• Profit is based on the risk (probability that the accounts receivable will not be paid) the factor assumes
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