st financing

8/19/2019 ST Financing

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5 C h a p

e r Sources of Short-Term

Financing

Sources of Short-Term

Financing


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Chapter 5 – Outline (1)

• Sources of Short-term Financing

• Spontaneous Financing Trade Credit

The Prompt Pament !iscount "#uses of Trade Credit

• $an% Operating &oans Short Term $an% Credit

&ine of Credit or 'eoling Credit "greement

nterest 'ates on &oans

"nnual nterest 'ate

Cleanup 'e*uirements


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Chapter 5 – Outline (+)

• Short-Term Credit Secured # Current "ssets 'eceia#les Financing

Pledging "ccounts 'eceia#le

Factoring "ccounts 'eceia#le

nentor Financing

Tpes of nentor Financing

• ,one ,ar%et nstruments

Commercial Paper $an%ers "cceptances

Securiti.ation of 'eceia#les


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Sources of Short-term Financing

• Spontaneous financing "ccounts paa#le and accruals

• Bank operating loans

'eoling credit agreement/ line of credit• Secured loans for accounts receivable and

inventory

• Money market instruments Commercial paper

$an%ers acceptances

Securiti.ation of receia#les


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Spontaneous Financing

• Accruals For e0ample/ mone ou oe emploees for or%

the hae performed #ut not et #een paid• Tend to #e er short-term

• Accounts payable ("2"3 trade credit) ,one ou oe suppliers for goods ou #ought on

credit

"ttractie source of financing

• 4o securit re*uired• nterest-free

Credit Terms3 Terms of trade specif hen ou areto repa the de#t


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Trade Credit

• Seller lends #uer purchase price fromtime of shipment to time of pament

• 4o securit and no interest

• Seller ma offer cash discount for earlpament

• Cost of forgoing a cash discount3

% discount 365APR = ×

!!% - % discount Fina" #a$ment date - ast discount date


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The Prompt Pament !iscount

Q: Vendor offers a discount of 2% if payment is made within tendays. If the discount is not taken, full payment is due in 30days. What is the annual cost of not accepting the 2%discount?

A:

3!.2"%

# $ a m p l e % discount 365

= ×!!% - % discount Fina" #a$ment date - ast discount date

2 365 = ×!! - 2 3! - !


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"#uses of Trade Credit

• "#uses of Trade Credit Terms Trade credit is no e0pected in man

#usinesses• Companies offer it #ecause the hae to

Stretching payablesa common a#use oftrade credit

• Paing paa#les #eond the due date ("2"3leaning on the trade)

• Slo paing companies receie poor credit ratingsin credit reports issued # credit agencies


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$an% Operating &oans

• 'epresent primar source of short-term loansfor most companies

• Proide financing for or%ing capital ande0penses

• "danced against alue of receia#les andinentor

• 'epaid from collections on receia#les

• ,a #e arranged for specific transactions or asrevolving credit agreement or line of credit


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&ine of Credit or 'eoling Credit"greement

• &ine of credit 4on-#inding agreement to #orro up to

predetermined limit at an time

• 'eoling credit

&egall commits the #an%

6suall secured 'e*uires commitment fee on un#orroed

funds


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• nterest 'ates on &oans Prime rate is rate that #an% charges its largest and

most creditorth corporate customers7

nterest rates on operating loans are usuall #ased

on #an%s prime rate plus a risk premium


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• &oan rates ill depend upon such factors as3 8o intense is competition among lenders for loan

#usiness9

8o large is the loan9

!oes #orroer hae good credit histor9

!oes #orroer hae ade*uate and relia#le cash flo9

!oes #orroer hae ade*uate securit9

s loan guaranteed under a goernment program9 :hat is term of the loan9

:hat is de#t-to-e*uit ratio9


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"nnual nterest 'ate

where r &nnual rate I Interest paid 'dollars(

) )rincipal d *um+er of days loan is outstanding

) 365r = ×

P d


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;0ample 5713 'eoling Credit

"greementQ: he &rcturus -ompany has a /0 million reoling credit agreementwith its +ank at prime plus 2.1%. )rior to une, the company had+orrowed " million that was outstanding for the entire month. nune /1, it took +orrowed 2 million. )rime is 4.1% and the +ank5scommitment fee is 0.21% annually.

What +ank charges will &rcturus incur for the month of une?

# $ a m p l e


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A &rcturus will hae to pay +oth interest on the money +orrowedand a commitment fee on the unused +alance of the reolingagreement.

6onthly interest rate ')rime 7 2.1%( ÷ /2 /%

6onthly commitment fee 0.21% ÷ /2 0.0208% " million was outstanding for the entire month of une

and 2 million was outstanding for /1 days of une, so thetotal dollar interest charges are

( ) × × =

/1

",000,000 0.0/ 7 2,000,000 10,00030

he commitment fee must +e paid on an aerage of1,000,000 that was unused during une, or

9 1,000,000 × .000208 /,0"0

9 otal +ank charges 1/,0"0

;0ample 5713 'eoling Credit"greement

# $ a m p l e


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Clean 6p 'e*uirements

• Theoreticall a firm can constantl roll-oer its short-term de#t $orro on a ne note to pa off an old note

• 'is% for #oth firm and #an%

• $an%s re*uire that #orroers clean up

short-term loans once a ear 'emain out of short-term de#t for certain

time period


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Short-Term Credit Secured #Current "ssets

• !e#t is secured # the current assets#eing financed ( accounts receia#le and

inentor)

• Common in seasonal #usinesses such as

retail


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'eceia#les Financing

• 'eceia#les Financing3 &enders ma e0tend credit #ac%ed # the

alue of accounts receia#le

'eceia#les ma ma%e e0cellent collateral3• Fairl li*uid

• ;as to recoer in eent of default

• Collectibility of accounts is %e issue

Common arrangements

• Pledging–Firm retains title

• Factoring–Firm sells "


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Pledging "ccounts 'eceia#le

$orroer uses "


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;0ample 57+3 Pledging "ccounts'eceia#le

Q: he :ilraine ;uilt -ompany has an aerage receia+les+alance of /00,000 which turns oer once eery "3 days. Itgenerally pledges all of its receia+les to the -ooperatie


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;0ample 57+3 Pledging "ccounts'eceia#le

A: &erage =eceia+les +alance /00,000

&erage loan outstanding !1% $ /00,000 !1,000

Interest rate 1% 7 "% 4%

=eceia+les pledged in year /00,000 $ 3>1 10 !30,000 &dministratie fee /.1% $ !30,000 /0,410

% of the aerage loan +alance/0,410 !1,000 /".>%

&nnual financing cost 4% 7 /".>% 23.>%

# $ a m

p l e


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• Firm sells "ccounts 'eceia#le to lender(at a seere discount) and lending firm

(factor) ta%es control of the accounts "ccounts receia#le are no paid directl to

factor

Factor usuall reies accounts and onlaccepts accounts it deems creditorth


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• Factors offer ide range of serices

Perform credit chec%s on potential customers

"dance cash on accounts it accepts or remitcash after collection

Collect cash from customers

"ssume #ad-de#t ris% hen customers dontpa


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nentor Financing

• 6se firms inentor as collateral for ashort-term loan

• Popular #ut su#>ect to num#er ofpro#lems &enders arent usuall e*uipped to sell

inentor Speciali.ed inentories and perisha#le goods

are difficult to mar%et


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Tpes of nentor Financing

• Blanket lienslender has a lien (claim) against allinentories of #orroer

• $orroer remains in phsical control of inentor

• Trust receipt (chattel mortgage agreement)collaterali.ed inentor is identified # serial num#erand cant #e sold ithout lenders permission

• $orroer remains in phsical control of inentor

• arehousingcollaterali.ed inentor is remoedfrom #orroers premises and placed in a arehouse(#orroers access controlled # third part)

• :hen inentor is sold/ lender is informed to e0pect monefrom #orroer soon


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,one ,ar%et nstruments

• &arger corporations ma sell short-termde#t instruments in the mone mar%et

• "nother method to #orro to meettemporar cash needs

• nstruments include commercial paper/

bankers! acceptances andsecuriti"ation of receivables


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Commercial Paper

• 4otes issued # large/ financiall-strongfirms and sold to inestors 6nsecured (usuall)

$uers are usuall other corporations andfinancial institutions

,aturit is less than +?@ das

Considered er safe inestment/ therefore

pas a relatiel lo interest rate (sold at adiscount)

4o fle0i#ilit in repament terms


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Commercial Paper

• "nnual nterest 'ate on !iscounted,one ,ar%et Securit

whereM = Maturity (face) value of the security

P = Discounted price (net proceeds on issue)

d = Number of days to maturity r = Annual interest rate

d (,-P)

P AB5r


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$an%ers "cceptances

bankers! acceptancecreated hen a #an% addsguarantee of payment to the promissor note ordraft of the issuer (corporate #orroer)

ssuer receies mone from #an%7 $an% then sells

the #an%ers acceptance in the mone mar%et to aninestor7

"t maturit/ #an% repas face alue to the inestorand the issuer repas #an%

Traded on a discount #asis to ield interest rateslightl loer than that of commercial paper

6sual terms are A@/ B@/ and D@ das7


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Securiti.ation of 'eceia#les

• Sale of receia#les # large firms inpublic offerings arranged # securitiesdealers

• The issuing firm thus receies immediatecash for future cash flos

• Financing is raised at a relatiel lo

cost/ often loer than prime orcommercial paper rate/ #ecause the issueis asset#backed7

st financing

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