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