5. Contents
Sources of Short term financing:
• Trade Credit (detailed description)
• Unsecured loans
• Secured loans
• Factoring accounts receivables
• Inventory
• Commercial paper
6. • Open Accounts:
Form of trade credit in which the buyer establishes a line of
credit with the seller. There after no special arrangements
need to be made for each transactions.
• Notes Payable OR Promissory Note:
The buyer signs a note that evidences a debt to the seller.
• Trade Acceptances:
The seller draws a draft on the buyer that orders the buyer
to pay the draft at some future time period.
A firm buying goods and services on credit enters an
amount, equal to
the cost of the goods and services, on its balance
sheet as account
payable.
Trade Credit:
TYPESOF TRADECREDIT:
7. Factors that influence the credit terms
• Merchandise Characteristic:
The terms of sale are influenced by seasonality, perishability ,
obsolescence cost and demand pattern of merchandise sold on credit.
• Status of Buyer: when costs can be fully passed on through higher
prices to the buyer by the seller.
• Status of Seller: when trade costs cannot be passed on to buyers
because of price competition and demand.
• Industry Practice: The desire to deviate to any extant from
industry practice is stimulated by the financial strength of the buyer
and seller
8. Types of credit terms
• Credit Period Only: A credit term that means “ cash on delivery”
and specifies that goods must be paid for, in full, upon delivery, it
is used for uncredit worthy customers.
• EndOf Month(EOM):
A credit terms that means “End Of Month” and
indicates that the credit period begin on the first of
the following month.
9. • Cash Discount AndEOM:
A credit term which specifies that both a discount period and a credit
period begin the first day of the next month.
• Receipt Of Goods (ROG):
A credit term that means “Receipt Of Goods” and indicates that the
credit period does not began until the day the goods are received.
10. • Dating:
Credit terms that encourage the buyer of seasonal products to take
delivery before the peak sales period.
• COD andCBD: The buyer pays cash on delivery or
cash before delivery. This reduces the seller’s risk
under COD to the buyer refusing the shipment or
eliminates it completely for CBD.
11. WHEN TO USE OF TRADECREDIT
• The use of trade credit is a way of life in the industrial sector of the
economy.
• For a firm with increasing sales volume, trade credit
“spontaneous” or automatic financing for part of the increase in
working capital requirement.
• Trade credit should be used is governed by the explicit and implicit
cost of trade credit.
12. Unsecured Loans – A form of debt for money borrowed
that is not backed by the pledge of specific assets.
Dimensions Of Unsecured Loans:
• Unsecured loans are used primarily for small,
short-term expenses, such as medical crises or
wedding or funeral costs.
• An unsecured loan is a loan in which you simply
use your credit rating to help you borrow money
from the lending institution.
• People who do not have assets or do not want to
provide assets as a guarantee may prefer this type
of loan as an alternative.
13. • Line of Credit
• Revolving Credit Agreement
• Transaction Loan
• 1-Line of Credit (with a bank) -- An informal
arrangement between a bank and its customer specifying the
maximum amount of credit the bank will permit the firm to owe
at any one time.
• One-year limit that is reviewed prior to renewal to determine if
conditions necessitate a change.
• “Cleanup” provision requires the firm to owe the bank nothing
for a period of time.
14. 2-Revolving Credit Agreement--
A formal, legal commitment to extend credit up to some maximum
amount over a stated period of time.
COMMITMENT FEE:
A fee charged by the lender for agreeing to hold credit available.
Agreements frequently extend beyond 1 year.
3-Transactions Loans:
A loan agreement that meet the short-term funds need of the firm
for a single, specific purpose.
The loan is paid off at the completion of the project by the firm
from resulting cash flows.
15. COMPENSATING BALANCE--
• A minimum balance that must be maintained in an account.
• The compensating balance is often used to offset a portion of the cost that a
bank faces when extending a loan or credit to an individual or business, and is
usually calculated as a percentage of the loan outstanding.
• Bank requires that 10 to 20 % of the borrowing on a line credit be kept as a demand
deposit balance
Effective Interest Rate--
Effective rate is the interest rate on a loan or financial product
restated from the nominal interest rate as an interest rate with
annual compound interest payable in arrears.
Uses--
It is used to compare the annual interest between loans with
different compounding terms (daily, monthly, annually, or other).
The effective interest rate differs in two important respects from
the annual percentage rate (APR).
EFFECTIVE INTEREST RATE= STATED INTEREST RATE
1- COMPENSATING BALANCE FRACTION
16. SECUREDLOANS
A loan for which the bank requires no collateral.
Short term secured loans are typically secured by receivables and
inventories.
Land ,buildings ,equipment are used to secured term and long term
borrowing.
17. PLEDGINGACCOUNT RECEIVABLE
One of the most liquid assets accounts.
Loans by commercial bank or finance companies (banks offer
lower interest
rate).
The lender will evaluate the quality of receivable pledge, size of
account.
Loans evaluation are made on:
Quality: Not all individual accounts have to be accepted (may
reject on aging).
Size: Small account may be rejected as being too costly(per dollar
of loan) to handle by the institution.
18. Pledging Procedure
The loans value of receivables has been established , the
borrower send to the lender a list of account, billing dates
and amount involved.
Two types of pledging procedure:
NON NOTIFICATION: On a non-notification basis the is not
informed of the financial arrangements between borrower and
lender.
The account remits payments to the borrower ,who forward it to
the lender.
NOTIFICATION: On a notification basis the borrower notifies its
accounts the payment on the receivables are to made directly to the
lender.
19. Factoring Receivable:
Factoring receivables is different from pledging receivables in that
receivables are sold to the factors or financials institutions.
• Service provided by a factors
• Mechanics of factoring.
• Factoring costs
InventoryFinancing:
Inventories are also used frequently as collateral for short –term
loans.
Relatively liquid assets accounts.
20. CHARACTERISTICSOF INVENTORY
The inventory can be utilized as collateral for short-term loans is dependent
upon its three major characteristics:
• Marketability.
• Perishability.
• Price stability
TYPESOF INVENTORY:
There are four types of inventory.
• FLOATING LIEN
• TRUST RECEIPTS
• TERMINAL WAREHOUSE RECEIPTS:
• FIELD WAREHOUSE RECEIPTS:
21. • FLOATING LIEN: A loan arrangement used when accounts
receivable and inventory are used as collateral. With this, there is a
general loan against the accounts on the goods without any records
being kept on specific ones.
• TRUST RECEIPTS: Short term financing instrument used in
inventory pledging, in which the borrower acknowledge its hold
merchandise in trust for the lender. It is used when the goods are
more easily held by the borrower and when they can be identify by
serial number.
• TERMINAL WAREHOUSE RECEIPTS: Short term financing
instrument used with pledge inventory in which the goods are
transferred to a public warehouse and released only by authorization
of the lander. It is used when there is concerned that the borrower
might liquidate the inventory without paying.
• FIELD WAREHOUSE RECEIPTS: Short term financing instrument
used with pledge inventories where by the goods are transferred to a
specified warehouse on the borrower property. The goods cant be
released with out the landers authorization. This is done in cases
when it is impractical to move than inventory
22. COMMERIALPAPER
DEFINITION:
• Commercial paper refers to short –term, unsecured
promissory notes, generally issued by large
corporations.
• Commercial paper market is composed of the dealer
and direct-placement markets.
ADVANTAGES:
• Cheaper than a short –term business loan from a
commercial bank.
• Dealers requires a line of credit to ensure that the
commercial paper is paid off.