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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 may be 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- A time draft drawn
against a deposit in a commercial bank but with
payment at maturity guaranteed by the bank.
 Letter of Credit- Promise to make payment to a
party upon presentation of a draft or bill.
 Standby Letter of Credit- guarantees that the bank will
make funds available if the company cannot or doesn’t
wish to meet a major financial obligation
 Reverse Repurchase Agreement- Corporate investment
manager may negotiate with the bank to sell to the bank
a specific dollar amount of marketable securities
currently held in the firm’s investment portfolio. Also
termed as Reverse Repo.
 Short-term
promissory note issued by a
corporation for a fixed maturity at a fixed
discount rate.
• Can be issued directly by borrower or through a
dealer network.
• Most commercial papers are sold on a discount,
where the paper is sold at a price less than its
face value or maturity value.
• Interest bearing commercial papers are less
popular pricing format. Here, the borrower
repays the principal and the quoted interest over
the amount borrowed.
Here
Out-of-Pocket Cost
- Interest Expense: Calculated by discounting the face value of the paper
- Fees: Usually the commitment fee that back up the commercial paper,
this is based on the unused portion of the line
- Dealer fee: Compensate the investment banker that underwrites the
commercial paper
Usable Funds
- Represents the net proceed firm receives from the
commercial paper, the amount received is reduced by the
amount of discounted interest paid.
M= Number of days in which funds are borrowed
Here
Out-of-Pocket Cost
- Interest Expense: based on the stated interest rate and the amount
borrowed
- Fees: Usually the commitment fee for the line of credit, which is based
on the unused portion of the line
Usable Funds
- Represents the net proceed firm receives from the Line of
credit, the amount received is less than the amount
borrowed if the bank requires a compensating balance.
M= Number of days in which funds are borrowed
Short-term financing alternatives in this
chapter differ from spontaneous financing
sources such as payables and accruals.
 This is important for maintaining liquidity.
 The chapter began with a discussion of
financing using 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.
