Transcript Block Hirt Short

Chapter
8
Sources of Short-Term
Financing
Prepared by:
Terry Fegarty
Seneca
College
Revised by:
PChua
Ref:
Block et al
Gitman et al
McGraw-Hill Ryerson
2003 McGraw-Hill
RyersonLimited
Limited
©2003©McGraw-Hill
Ryerson
PPT 8-2
Chapter 8 – Outline








Sources of Short-Term Financing
Interest Rates Terminology
Trade Credit from Suppliers
Short-term Bank Loans – Types, Characteristics and
Features
Corporate and Foreign Borrowing
Accounts Receivable Financing
Inventory Financing
Summary and Conclusions
© 2003 McGraw-Hill Ryerson Limited
Sources of Short-Term Financing


Unsecured Sources of Short-Term Financing
- Spontaneous
- Accounts Payables, Accruals
- Negotiated
- Bank Loans: Promissory Notes, Lines of Credit,
Revolving Lines of Credit, Letter of Credit
- Commercial Paper
- EuroDollar Loans
Secured Sources of Short-Term Financing
- Pledging Accounts Receivables
- Factoring Accounts Receivables
- Using Inventory as Collateral
© 2003 McGraw-Hill Ryerson Limited
Figure 8-1
PPT 8-4
Structure of corporate debt, 2000
© 2003 McGraw-Hill Ryerson Limited
Primer on Interest Rates
Prime Rate:
 the interest rate charged to a bank’s best customers
 is scaled up proportionally according to customer’s credit
rating (1-3% above prime)
 is based on Bank of Canada Rate, usually 150 basis points
above it
Bank of Canada Rate:
 the rate Bank of Canada uses to control inflation and the value
of Canadian dollar in relation to other currencies
Bank Rate:
 the rate at which Chartered Banks can borrow from Bank of
Canada
Effective Interest Rate:
 the actual interest rate or “true” cost of a loan, including
interest on interest (compounding)
© 2003 McGraw-Hill Ryerson Limited
Figure 8-2
PPT 8-10
Prime interest rate movements
© 2003 McGraw-Hill Ryerson Limited
Accounts Payables








Provided by sellers of goods or services
Major source of short-term financing for over 50% of firms
No need to formally negotiate; invoice will serve as the credit
agreement
Spontaneous -expands or contracts as sales rises or falls
No explicit cost (interest-free)
No collateral to pledge
It is usually a 30-60 day grace period before a bill is due
A cash discount is often given if payment is made within a
specified time

Ex., 2/10 net 30 means a 2% discount is given if paid in 10
days; if not, the full amount is due in 30 days
© 2003 McGraw-Hill Ryerson Limited
Timing and Cash Discount
© 2003 McGraw-Hill Ryerson Limited
Managing Accounts Payable
Goal: save cash without damaging credit
 Analyzing Credit Terms:
 Taking the Cash Discount
 Giving up the Cash Discount
 Delaying payment beyond the credit terms if possible
CGUCD = [d%/(100%-d%)]*(365/(N)
CGUCD = Cost of Giving Up Cash Discount;
d% = Cash Discount; N = Number of days payment can be
delayed by giving up discount.
© 2003 McGraw-Hill Ryerson Limited
Net Credit Position
PPT 8-6
Net Credit Position:
a firm’s Accounts Receivable (A/R) minus its
Accounts Payable (A/P)
 if A/R is greater than A/P, it is a net provider of trade
credit (positive number)
 if A/P is greater than A/R, it is a net user of trade
credit (negative number)
 larger firms tend to be net providers of trade credit,
while smaller firms are net users

© 2003 McGraw-Hill Ryerson Limited
Short-term Bank Loans - Characteristics





Major source of unsecured loans
Negotiated; results from actions taken by the Financial
Manager
More Popular than Commercial Paper; available to all sizes
of firms
Its intends to carry firms through seasonal peaks in
financing needs due to inventory and A/Rs build-up ; hence
self-liquidating, that is, the use to which borrowed money is
put provides the mechanism through which loan is repaid
Major Types of bank loans are:
- Promissory Notes
- Lines of Credit
- Revolving Lines of Credit
- Letter of Credit
© 2003 McGraw-Hill Ryerson Limited
Short-term Bank Loans – Common Features





Can be Fixed-Rate or Floating Rate, rates based on Prime Interest Rates
- Fixed Rate Loan is when the interest rate is set at the time loan is
negotiated
- Floating Rate Loan is when the Interest rate can vary based on the
changes in Prime rates during the life of a loan
- Interest Rate is prime rate + premium
Can be Discounted Loan or not
- Discounted Loan is when Interest is paid at the beginning of the loan
period
May have Compensating Balance Requirement - a bank requires a
minimum average account balance in order to qualify for a loan
May Require Commitment Fees
Payment can be on Installments
© 2003 McGraw-Hill Ryerson Limited
Types of Short-term Bank Loans
PPT 8-8
Promissory Note:





a note signed by the borrower, stating loan terms, loan maturity and
interest rate
short-term loan for a specific purpose
discounted loan or not
Fixed or variable interest rate
may require compensating balance
Line of Credit:





Agreement between a commercial bank and firm on a pre-approved
maximum amount of money to be made available to the firm at any
point in time over the life of the loan, typically 1 year
Loan amount available is not guaranteed but is subject to funds
availability
Very similar to credit card agreement
Fixed or variable interest rate
may require compensating balance
© 2003 McGraw-Hill Ryerson Limited
PPT 8-8
Types of Short-term Bank Loans - continued
Revolving Line of Credit:
 Bears all the features of a Line of Credit EXCEPT that it
is guaranteed
 Commitment Fees is usually required
 Fixed or variable interest rate
 may require compensating balance
Letter of Credit
 Purpose is to finance goods in transit (usually imports)
 A letter from a company’s bank to the company foreign
supplier, stating that the company’s bank guarantees
payment of the invoiced amount issued by the foreign
supplier if all underlying agreements are met
© 2003 McGraw-Hill Ryerson Limited
PPT 8-7
Chartered Banks in Canada
http://www.rbc.com/
http://www.cibc.com/index.html
http://www.bmo.com/
http://www.scotiabank.com/
http://www.tdbank.ca/index.html
http://www.nbc.ca
© 2003 McGraw-Hill Ryerson Limited
PPT 8-11
Corporate and Foreign Borrowing
Commercial Paper:




a short-term unsecured promissory note in minimum units of $50,000
sold (at a discount) by finance companies, other large corporations
cheaper than bank loans
total amount of commercial paper outstanding has increased greatly
in recent years
Eurodollar Loans:


loans from foreign banks are called Eurodollar loans
(U.S Eurodollars predominate)
Subject to exchange rate fluctuations
© 2003 McGraw-Hill Ryerson Limited
PPT 8-14
Accounts Receivable Financing
A/R financing includes 3 choices:
pledging accounts receivable as collateral for a loan
 an outright sale (factoring) of receivables to a
factoring company
 Asset-backed Securities: sale of receivables by large
corporations in public offerings

Tends to be a relatively expensive source of financing
© 2003 McGraw-Hill Ryerson Limited
Inventory Financing
PPT 8-15
 Inventory
may be assigned as collateral security
against an operating loan
 For
example, in a Trust Receipt
Is an instrument acknowledging that the borrower
holds the inventory and proceeds from sale in trust
for the lender
 when goods are sold, loan is repaid
 used by auto dealers, industrial equipment dealers,
television and home appliance dealers

© 2003 McGraw-Hill Ryerson Limited
Summary and Conclusions
Short-term
PPT 8-16
financing options
include:
trade credit from suppliers
bank operating loans
commercial paper for large
companies
Eurodollar or foreign currency
loans
financing secured by accounts
receivable or inventory
Bank operating loans move up or
down based upon the borrower’s
need for working capital, and incur
interest based upon the prime rate
© 2003 McGraw-Hill Ryerson Limited