Chapter

Sources of Short-Term
Financing

PPT 8-2

Chapter 8 - Outline
Sources

of Short-Term Financing
Trade Credit from Suppliers
Net Credit Position
Chartered Banks in Canada
Types of Short-term Loans
Interest Rate Terminology
Corporate and Foreign Borrowing
Accounts Receivable Financing
Inventory Financing
Summary and Conclusions

Sources of Short-Term Financing

There are various sources of short-term funds
available to a firm:
Trade Credit from Suppliers
Bank Loans
Corporate Promissory Notes
Bankers Acceptances
Foreign Borrowing
Loans Against Receivables and Inventory

PPT 8-3

Figure 8-1

Structure of corporate debt, 2000

PPT 8-4

PPT 8-5

Trade Credit from Suppliers

The

largest source of short-term financing for a

firm-over 50%
It is usually a 30-60 day grace period before a bill is
due
A cash discount is often given if payment is made
within a specified time

Ex., 2/10 net 30 means a 2% discount is given if paid

in 10 days; if not, the full amount is due in 30 days

Net Credit Position

PPT 8-6

Net Credit Position:

a firms Accounts Receivable (A/R) minus its
Accounts Payable (A/P)
if A/R is greater than A/P, it is a net provider of trade
credit (positive number)
if A/P is greater than A/R, it is a net user of trade
credit (negative number)
larger firms tend to be net providers of trade credit,
while smaller firms are net users

PPT 8-8

Types of Short-term Bank Loans

Line of Credit:

company is able to draw upon a yearly borrowing facility

arranged in advance
revolving credits are for periods longer than 1 year
general purpose loans

Transaction Loan:

short-term loan for a specific purpose

Compensating Balance:

when a bank requires a minimum average account balance in

order to qualify for a loan
can be thought of as a form of collateral
less common than in the past

Chartered Banks in Canada

http://www.rbc.com/
http://www.cibc.com/index.html
http://www.bmo.com/
http://www.scotiabank.com/
http://www.tdbank.ca/index.html
http://www.nbc.ca

PPT 8-7

Compensating Balance:
when

a bank requires a minimum average account

balance in order to qualify for a loan

can

be thought of as a form of collateral and

compensate the bank for its service

Compensating

balances raise the cost of a loan, the

borrower must borrow more than the amount
needed
Amount borrowed = amount needed/ (1-C)

less

common than in the past

PPT 8-9

Interest Rate Terminology

Prime Rate:
the interest rate charged to a banks best customers
acts as a benchmark for calculating other interest
rates

Effective Interest Rate:

the actual interest rate or true cost of a loan,

including interest on interest (compounding)

Figure 8-2

Prime interest rate movements

PPT 8-10

PPT 8-11

Corporate and Foreign Borrowing

Commercial Paper:

a short-term unsecured promissory note in minimum units of $50,000

sold (at a discount) by finance companies, other large corporations
cheaper than bank loans
total amount of commercial paper outstanding has increased greatly
in recent years

Bankers Acceptances

to finance goods in transit (particularly imports)

sold at a discount

Eurodollar Loans:

loans from foreign banks are called Eurodollar loans

(U.S Eurodollars predominate)
foreign interest rates may be lower

Figure 8-3

PPT 8-12

Corporate short-term paper outstanding

Figure 8-4

PPT 8-13

Comparison of commercial paper rate to

bank prime rate*

PPT 8-14

Accounts Receivable Financing

A/R financing includes 3 choices:
pledging accounts receivable as collateral for a loan
an outright sale (factoring) of receivables to a
factoring company
Asset-backed Securities: sale of receivables by large
corporations in public offerings

Tends to be a relatively expensive source of financing

Pledging accounts of receivable as

collateral

Convenient means of financing. Receivables levels are rising

as the need for financing is increasing.

Lender screens accounts and loans a percentage (60% 75%) of the acceptable amount.

Lender has full recourse against borrower.

The interest rate, which is usually in excess of the prime rate,

is based on the frequently changing loan balance
outstanding.

Factoring Receivables

Receivables are sold, usually without recourse, to a factoring

firm.

A factor provides a credit-screening function by accepting or

rejecting accounts.

Factoring costs.

Commission of 1%-3% of factored invoices

Interest on advances

Asset-backed public offerings

Public offerings of securities backed by receivables as

collateral is a recently employed means of short-term
financing. These have included mortgages, car loans and
credit car receivables. Credit ratings often are better than
the issuing firm.

Several problems must be resolved:

Image: Historically, firms that sold receivables were

considered to be in financial trouble.
Computer upgrading to service securities.
Probability of losses on default of underlying securities.

Inventory Financing

LT 8-8

Inventory

may be assigned as collateral security

against an operating loan.
The collateral value of inventory is based on several
factors.

Marketability
Raw materials and finished goods are more
marketable than goods-in-process inventories.
Standardized products or widely traded commodities
qualify for higher percentage loans.

Price Stability
Perishability
Physical control

Inventory control method

Blanket inventory liens: Lender has general claim against

inventory of borrower. No physical control.

Trust receipts: Also known as floor planning; the borrower

holds specifically identified inventory and proceeds from sale
in trust for the lender.

Warehouse: Goods are physically identified, segregated, and

stored under the director of an independent warehousing
company. Inventory is released from warehouse openly upon
presentation of the warehouse receipt controlled by the
lender.

Longer-term Loans
Term

LT 8-9

Loan (Instalment Loan):

loan for 1-7 years

interest rate may be fixed or change with prime rate
repaid in monthly or quarterly instalments
used to buy capital assets (ex; automobiles, property)

Summary and Conclusions

Short-term

PPT 8-16

financing options

include:
trade credit from suppliers
bank operating loans
commercial paper for large
companies
Eurodollar or foreign currency
loans
financing secured by accounts
receivable or inventory
Bank operating loans move up or
down based upon the borrowers
need for working capital, and incur
interest based upon the prime rate