1

Learning OutcomesChapter 16

Describe the characteristics of the various sources of short-term credit, includingAccrualstrade creditbank loanscommercial paper.

Discuss and compute the cost (both APR and rEAR) of short-term credit. Describe the procedures and benefits of usingaccounts receivableinventory to obtain secured short-term loans.

2

3

Short-Term Credit

Any liability originally scheduled for repayment within one year

4

Sources of Short-Term Financing

AccrualsContinually 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

5

Components of Trade Credit: Free versus Costly

“Free” Trade CreditCredit received during the discount period

Costly Trade CreditCredit taken in excess of “free” trade credit,

the cost of which is equal to the discount lost

6

Sources of Short-Term Financing

Short-Term Bank LoansMaturity typically 90 days

Promissory Notes specify terms and conditions:

• Amount, interest rate, repayment schedule, collateral, and any other agreements.

7

Sources of Short-Term Financing

Short-Term Bank LoansCompensating 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

8

Sources of Short-Term Financing

Short-Term Bank LoansRevolving Line of Credit

• Line of credit where funds are committed

Commitment Fee

• Fee charged on the unused balance of a revolving credit agreement

9

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

10

Sources of Short-Term Financing

Commercial PaperUnsecured short-term promissory notes

issued by large, financially sound firms to raise funds

11

Computing the Cost of Short-Term Credit

12

Computing the Cost of Bank Loans

Simple Interest LoanBoth the amount borrowed and the interest

charged on that amount are paid at the maturity of the loan

Face ValueThe amount of the loan (the amount

borrowed)

13

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

14

Computing the Cost of Bank Loans

Installment Loans: Add-on InterestInterest that is calculated and then added to

the amount borrowed to obtain the total dollar amount to be paid back in equal installments

15

Computing the Annual Cost of Bank LoansBorrowed Amount versus Required Amount

16

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

17

Accounts Receivable Financing

Pledging ReceivablesUsing accounts receivable as collateral for a

loan

RecourseThe lender can seek payment from the

borrowing firm when receivables’ accounts used to secure a loan are not collectible.

FactoringThe outright sale of receivables

18

Evaluation of Receivables FinancingAdvantagesFlexibilityCan be used as security for loans that otherwise

would not be grantedFactoring can provide services of a credit

department that would otherwise cost more.

DisadvantagesAdministrative costs may be excessive.Some trade creditors may refuse to sell on credit

to a firm that factors or pledges its receivables.

19

Inventory Financing

Blanket Liens

Trust Receipts

Warehouse Receipts

Acceptable Products

Cost of Financing

20

Evaluation of Inventory Financing

AdvantagesAmount of funds is flexible.Field warehousing increases the acceptability of

inventories as loan collateral.Often results in improved warehousing practices

DisadvantagesPaperworkPhysical separation requirementsFixed-cost element