L7 SHORT-TERM AND LONG-TERM FINANCING

• The owner’s investment in the company is referred to as owner’s equity or simply equity. The mix of the debt and equity that a company uses is known as its capital structure. The decision on how the firm should be financed, whether with debt or with equity, is referred to as the capital structure decision.
• Debt financing involves borrowing bank funds from creditors with the stipulation of repaying the

  borrowed funds plus interest at a specified future time. For the creditors, the reward for providing the

  debt financing is the interest on the amount lent to the borrower.
• • Debt financing can also be short-term or long-term. Generally, short-term debt is used to finance

  current activities, such as operations, while long-term debt is used to finance assets such as

  buildings and equipment. Banks and nonbanks are two (2) sources of long-term funds.
• Commercial banks – These banks have mostly retail customers. Its main business is lending.

  Many transactions take place in a commercial bank, and it is usually not very large in size. To

  reach more clients, a commercial bank puts up many branches in different locations. They want

  to be closer to their market to serve them better and faster.
• Universal banks – These banks are similar to commercial banks but are licensed to do more sophisticated banking services than commercial banks. Their clients are the top corporations of

  the country and global businesses. They lend to other companies, manage their corporate funds, invest their portfolio, and advise these companies on financial market movements and directions. Their transactions are usually larger than commercial banks.
• Investment banks – These banks offer sophisticated banking services but are more

  specialized. They focus on trading, fund management, and portfolio management.
• types of banks:

  1. Commercial banks
  2. Universal banks
  3. Investment banks
  4. Nonbanks TYPES
  5. Investment companies
  6. Insurance companies
• Bank credit is the banking system's borrowing capacity provided to an individual/business. A company or an individual’s bank credit depends on the borrower’s ability to repay and the total amount

  of credit available in the banking institution. Lenders use the 5Cs of credit to gauge whether to

  approve a loan.
• 5Cs of credit:

  1. Conditions
  2. Capacity
  3. Collateral
  4. Character
  5. Capital
• Conditions – These refer to the intended purpose of the loan. The loan size in relation to the

  specific use will help the lender evaluate your loan request. Conditions also include the national,

  industry, and local economic situation. An unstable economic situation may negatively affect a

  loan application.
• Capacity – Lenders need to determine if borrowers can comfortably afford the payments. The

  borrower’s income and employment history are good indicators of the borrower’s ability to pay

  outstanding debt. Income amount, job stability, and type of income may also be considered. The

  debt to income ratio of the borrower may be evaluated. This particular ratio compares debts to

  the before-tax-income.
• Collateral – Secured loans require collateral, which the borrower owns that will guarantee

  payment. It assures the lender that the lender can obtain the collateral if the borrower does not

  pay the loan. The value of the collateral will be evaluated, and any existing debt secured by the

  collateral will be subtracted from the value.
• Character – This is sometimes known as credit history. It refers to the borrower’s reputation or

  track record for repaying debts. A person’s character can be seen in the credit history and the

  lenders that have extended credit to them, the amount of credit they have, and their payment

  history.
• Capital – It is the money invested in the business and indicates how much is at risk if the

  business fails. Capital also represents the savings, investments, and other assets that can help

  repay the loan.
• Insolvency is the inability to pay debts on time. It is the temporary insufficiency of cash. On the other

  hand, bankruptcy is a legal process wherein the assets of a debtor are distributed to the creditors to

  pay his/her debts.
• personal net worth is the value of an individual’s assets, cash, savings, real estate, cars, stocks,

  bonds, or jewelry, less all debts, such as credit card debts, monthly bills, and loans. A personal

  balance sheet will allow an individual to identify his/her short-term and long-term assets.
• credit committee is a group of officers responsible for assessing a potential borrower's credit

  standing and debt-paying ability.
• Credit ratings estimate the ability of a person or organization to fulfill their financial commitments

  based on previous dealings.
• A credit analyst is someone who evaluates the borrower’s financial standing by reviewing his/her

  financial statements. A credit analyst is usually needed for corporate or business clients. The credit

  analyst evaluates statistics and analyzes corporate records, including payment plans, savings data,

  payment history, and purchase activity.
• Businesses need funds for several reasons.

  • For working capital

  • For capital expenditures

  • For debt servicing
• For working capital – Funds can be used for the business's day-to-day operations. Working

  capital refers to the current assets and current liabilities of the business.
• For capital expenditures – Long-term funds can be used for capital expenditures or long-term

  investment opportunities, such as investing in real estate or new equipment and technology.

  Some government regulations, such as anti-pollution ordinances or health laws, may require

  additional investments for the changes in the business operations.
• For debt servicing – Funds can also be used to pay for debts.