Chapter 16

Short-Term Business FinancingShort-Term Business Financing

© 2000 John Wiley & Sons, Inc.

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Chapter Outcomes NWC Identify and describe strategies for

financing working capital. Identify and briefly explain the factors that

affect short-term financing requirements. Identify the types of unsecured loans

made by commercial banks to business borrowers.

Describe the use of accounts receivable, inventory, and other sources of security for bank loans.

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Explain the characteristics, terms, and costs of trade credit.

Explain the role of commercial finance companies, factors, Small Business Administration, and commercial paper in providing short-term business financing.

Chapter Outcomes, continued

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Strategies for Financing Working Capital

Working capital Net working capital NWC and financing strategy

– If NWC>0

$ of current assets financed with long-term funds

– If NWC<0

$ of fixed assets financed with current liabilities

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Another way to look at a firm’s assets...

Fixed Assets Permanent current assets Temporary current assets Asset levels fluctuate over time for a

firm

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Asset Trends for a Growing FirmA

sset

s ($

)

Time

Fixed Assets

Permanent Current Assets

Temporary or Fluctuating Temporary or Fluctuating Current AssetsCurrent Assets

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Asset Trends for a Growing Firm:Maturity Matching

Ass

ets

($)

Time

Fixed Assets

Permanent Current Assets

Temporary or Fluctuating Temporary or Fluctuating Current AssetsCurrent Assets

Lon

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Asset Trends for a Growing Firm:Aggressive Financing

Ass

ets

($)

Time

Fixed Assets

Permanent Current Assets

Temporary or Fluctuating Temporary or Fluctuating Current AssetsCurrent Assets

Lon

g-te

rm f

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Asset Trends for a Growing Firm:Conservative Financing

Ass

ets

($)

Time

Fixed Assets

Permanent Current Assets

Temporary or Fluctuating Temporary or Fluctuating Current AssetsCurrent Assets

Lon

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Basic Financing Strategies

Maturity matching

Aggressive

Conservative

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Influences on the short-term/long-term financing decision

Risk/return implications Rate volatility Credit availability/crunch Operating characteristics of firm Flexibility Ease of future financing

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Patterns of Short-Term and Long-Term Financing over Time

Pattern of Short-Term Financing

Pattern of Long-Term Financing

Time

Time

$

0

$

0

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Commercial Bank Lending

Line of Credit

Revolving Credit Agreement

Accounts Receivable Financing

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Line of Credit

Clean up period Periodic re-approval Compensating balance versus fees

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Revolving Credit Agreement

Commitment by bank Charge on unused funds

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Accounts Receivable Financing

Pledging receivables– <80 percent of AR value

Interest rate + fees

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Computing interest rates

EAR = (1 + APR/m)m - 1 $10,000 loan, 6 months, 8%APR EAR = (1 + .08/2)2 - 1 = 8.16%

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Discounted Loans

Discounted loan $ received = loan amount - interest = $10,000 - $400 = $9600

Periodic rate = $400/9600

APR = 8.51% Loan request = funds needed

1 - discount %

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Inventory Loans

Percent of value lent depends on inventory characteristics

Blanket inventory loan Trust receipt Warehouse receipt

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Loans can be secured by...

Stock and bonds Cash value of life insurance policy Co-signer

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Trade Credit

Net date Trade discounts

2/10 net 30 Cost of trade credit

Pay $98 within 10 days or pay $100 within 30 days

Cost: extra $2 for delaying 20 days

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Cost of Trade Credit

Cost: extra $2 on a $98 charge for delaying 20 days

Approx. effective cost = 2/98 x 365/20 = 37.2%

General formula:

Percent discount x 3 6 5 days

100%-discount % net days-discount days

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Commercial Finance Companies

Organization without a bank charter that advances funds to businesses

– discounts receivables

– secured machinery loans

– inventory loans

– leases Higher cost than bank loans

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Factors

Purchases receivables and assumes credit risk

Can supplement or replace a firm’s credit department

Two types of factoring:– maturity factoring– advance factoring

Cost: interest plus charges

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Other sources

Small business:– SBA guaranteed loans

Large business:– commercial paper– proceeds =

issue size less interest less

placement fees