Download Short-term financing

Sources of ShortTerm Capital
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By: Mrs. Belen Apostol
Sources of Short-term Capital
• The total business finance function is
composed of three segments:
1. Short-term financing
2. Intermediate-term financing
3. Long-term financing
»Short-term financing – deals with
the demand for supply of shortterm funds which may either be
secured or unsecured.
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Advantages of Short-term Credits
1. They are easier to obtain – the risk involved in
lending funds varies according to the length of
payment period.
e.g. long-term credits are more risky than short-term credits
from the creditors point of view.
2. Short-term financing is less costly – short-term
credit is often granted by creditors at less cost
3. Short-term financing offers flexibility to the
borrower – the debtor may use other sources of
credit after the short-term credit is settled.
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Disadvantages of Short-term Credits
1. Short-term credits mature more frequently –
firms with slow moving inventories like
manufacturing capital goods worry about shortterm creditors more often.
2. Short-term debt may at times, be more costly
than long-term debts-risk, collateral, general
economic outlook and size of the loan are taken
into consideration. Short-term credit may prove to
be more costly.
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The Suppliers of Short-term Funds
1.
2.
3.
4.
5.
6.
7.
Trade creditors
Commercial banks
Commercial paper houses
Finance companies
Factors
Insurance companies
Company accruals
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Trade Creditors
Trade creditors – credit extended by suppliers to
buyers for use in manufacturing, processing, or
reselling goods for profit. (from firm to another firm)
- usually unsecured
- also known as trade credit, commercial credit,
mercantile credit or accounts receivable credit.
- appears as accounts receivable/ notes receivable
in the books of the creditors, and as accounts
payable or notes payable in the books of the debtor.
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Trade Creditors
Consumer credit – credit extended to a final consumer.
Installment credit – credit extended to a firm in the
purchase of machinery and equipment and secured
by the equipment sold.
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Trade Credit Instruments
1. Open-book credit – constitutes a bulk of trade
credit, unsecured and permits payment for goods
delivered in a specified number of days.
- source of inventory financing
2. Trade Acceptance – a time draft drawn by a seller to
a purchaser, payable to the seller as payee, and
accepted by the purchaser as evidence that goods
shipped are satisfactory and that the price is due and
payable.
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Trade Credit Instruments
3. Promissory Note – unconditional promise in writing
made by one person (maker) to another (bearer),
engaging to pay on demand or at a fixed or
determinable future time, a sum certain in money.
- made by a buyer who has a weak credit position.
Advantages:
1. the time and amount of payment are indicated,
avoiding litigation over such matters
2. may be endorsed to other parties allowing the
creditor immediate use of funds tied up in such credit
arrangement.
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Trade Credit
Cost of Trade Credit.
Firms extending trade credit provide incentives to
firms who settle their accounts early. Those who do
not avail of the trade discount incurs cost related to
the trade credit which may be computed as follows:
Annual cost of
Not taking
Discount
Discount
= ------------1 – Discount
360 days
x
---------------------Number of - Discount
day’s credit period
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Trade Credit
Cost of Trade Credit.
If the credit term is 2/10, net 30 , the annual cost is
computed as follows
Annual cost of
Not taking
Discount
.02
= ------------1 – 0.02
.02
= ------------.98
=
360
---------------------------30 days – 10 days
x
x
360
---------------------------20
36.73%
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Commercial Banks
Commercial Banks – institutions which individuals or
firms may tap as a source of short-term financing.
- corporations which accept or create deposits
subject to withdrawal by check.
1.
2.
3.
4.
Four Components:
Commercial Banks
Development Banks
Savings Banks
Rural Banks
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Commercial Banks
Short-term loans – those with maturity periods of one
year or less
-generally offered by commercial banks for
purposes which included financing of business
activities.
Two types of Short-term loans
1. Unsecured loan (clean loan) - does not require a
collateral
2. Secured Loans – requires a collateral back-up usually
for accounts receivable financing or inventory financing.
(a collateral is usually required when the credit standing
of the borrower is inadequate to permit unsecured loan).
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Commercial Paper Houses
Commercial Paper – short-term promissory note,
generally unsecured which is sold through
commercial paper dealers or directly to investors.
- used to finance companies and business firms that
borrow funds in the money market.
Commercial Paper Houses (CPH) – firms that buy
commercial papers.
- finance short-term fund requirements of
borrowing firms.
- include banks and other financial
institutions, like those engaged in selling
insurance, educational, pension and mortuary plans.
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Finance Companies
Finance Companies – engaged in making short and
intermediate term installment loans to consumers,
factor or finance business receivables, and finance
the sale of business and farm equipment.
- funds are raised by issuing stock, bonds,
borrowing from banks, and selling their commercial
papers.
Three major types of finance companies:
1. Sales finance companies
2. Business or Commercial finance companies
3. Personal finance companies
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Finance Companies
Sales Finance Companies – firms specializing in the
purchase of retailers of the installment receivables
arising out of retail sales of automobiles, household
appliances, industrial equipment, farm equipment,
and other durable goods sold on the installment
payment plan.
Business or Commercial Finance Companies – lend
directly to a wide variety of businesses, mainly of
small and medium size. Short-term loans are granted
by this type of finance companies against the security
of
assigned accounts receivable, inventory, and
equipment.
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Finance Companies
Business or Commercial Finance Companies (cont)
When using accounts receivable as collateral, the loan
arrangement may be considered as:
1. Non-notification plan – the debtors of the borrowing firm are
not aware that their accounts have been pledged as collateral
for a loan from a finance company.
2. Notification plan – debtors are informed that their accounts
have been pledged as collateral for a loan from a finance
company.
Personal Finance Companies – engaged principally in
personal loans. (may include miscellaneous
business loans & commercial accounts
receivable loans.)
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Factors
Factoring – purchase of accounts receivables outright
without recourse to the seller for credit losses.
- the factor takes it upon himself to collect the
funds from the client’s customers, absorbing any
credit losses incurred.
A claim for defective goods or dispute concerning
shipments, is not the responsibility of the factor.
Advantages:
1. Receivables provide collateral for a loan that might
not be otherwise available to the firm
2. Accounts receivable financing provides flexibility to
the firm.
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Insurance Companies
Insurance companies – provide a stable source of
short-term funds.
- invest on short-term commercial papers
and promissory notes
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Company Accruals
Accrual – expense that has been incurred but has not
yet been paid.
- provide a source of short-term financing for
business firms.
Two forms:
1. Accrued Wages and Salaries – salaries are paid as
soon as they are rendered.
2. Accrued taxes – taxes has a longer time lag
before it becomes due.
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Financing Requirements of the Firm &
the Sources of Short-Term Capital
Financing Requirements of the Firm
Short-term
Medium-term
Long-term
Open book
Trade
creditors
Commercial bank
Trade acceptance
Promissory note
Secured loan
Unsecured loan
Commercial paper houses
Finance companies
factor
Sales finance companies
Business finance companies
Personal finance companies
Insurance companies
Company accruals
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Thank you
for
Listening!
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