Chapter 7: Short and medium term finance

• Medium term

  more than one year but less than 5
• Short term finance

  Less than one year
• Three forms of medium term finance

  Credit sale, leasing, bank loans
• Credit sale


  A normal sale of a good together with an agreement that payment will be made by a series of regular instalments over a set period of time. Legal ownership passes to buyer at outset
• What happens to the seller if the buyer defaults on credit payment?

  Can't reclaim goods, sue for payment through court
• What happens if the seller takes the buyer to court and they still fail to pay?

  Bailiffs sent to their home to seize possessions equal in value to the amount owed
• A lease


  An agreement where the owner of an asset gives the lessee the right to use an asset over a period of time, in return for a regular series of payments. Legal ownership does not change hands
• Sometimes the lessor gives the lessee the option to

  To buy the asset at the end of the lease period
• Two types of lease

  Operating leases and finance leases
• Operating leases


  The owner of the asset will retain most of the risks associated with owning the asset. The lease is for a period substantially shorter than the likely life of the asset
• Finance lease


  The lessee takes on most of the risks associated with owning the asset. The lease will be for a similar period to the right of the asset
• The present value of payments for a finance lease is shown in the lessee's balance statement twice

  As an asset and as a corresponding liabilty
• What does the lessee get

  Economic benefit and profits
• A bank loan


  A form of medium term borrowing from a bank where the full amount of the loan is paid into the borrower's current account and the borrower undertakes to make interest payments and capital payments on the full amount of the loan
• what is the benefit of a finance lease

  Ownership transferred to the lessee when the term is over
• What is the benefit to the lesor?

  Regular payments
• Bank loans


  Medium term borrowing from a bank where the full amount of the loan is paid into the borrower's current account and the borrower undertakes to make interest payments and capital repayments on the full amount of the loan
• How are bank charges secured?

  On the borrower assets as a floating charge: all the assets of the company are assigned as security for the loan
• How is the interest rate on bank loans determined?

  Variable or fixed, linked to prime or JIBAR. A margin above the bank's own base rate or a margin over a benchmark interest rate such as SONIA
• JIBAR

  Johannesburg Interbank Average Rate
• SONIA

  Sterling overnight index average. The avg rate at which banks borrow funds overnight from other institutions
• Loan facilities


  The borrower can take out the loan in instalments, giving the bank a few days notice before taking out the next bit
• Companies often arrange lines of credit with their banks, enabling them to borrow money when needed. Flexibility ito the timing and use of the money.
• Revolving lines of credit

  Once an amount has been repaid, it becomes available again
• Prime rate


  The cost at which banks are willing to lend money to consumers. Interest rate a consumer is charged when they borrow from a commercial bank
• Repo rate


  The amount a commercial bank is charged when they borrow from the reserve bank
• Reserve bank governor


  Lesetja Kganyago
• Multi currency loans

  Banks act as a middle man to borrow money in which currency looks the best value to borrow in and swops into the required currency
• Syndicated loans


  Loan facility provided by a group of banks bc the sums to be borrowed are larger than any one bank would happily lend on a single project
• Short term finance options

  Bank overdrafts, trade credits, factoring, bills of exchange, commercial paper
• Bill of exchange and commercial papers are securities meaning

  They can be sold from one investor to another
• Bank overdraft


  Short term borrowing from a bank where the borrower is granted a facility to draw money out of a current account such that it becomes negative down to an agreed limit
• Interest on overdrafts

  Variable, often daily. Higher than on a loan however only pay interest on the facility that is actually used
• Payment of an overdraft


  No explicit arrangement however a bank can demand immediate repayment with no prior notice
• Why are overdrafts bad long term

  Vulnerable to banks continuing support. Lack of liquidity with an overdraft being called in causes bankruptcy not fundamendal lack of profit
• Bank overdraft vs lines of credit

  OD is associated with a current acc, so is only available from banks where the borrower has an acc. OD smaller amts of borrowing and short term
• Trade credit 


  An agreement between a company and one of its suppliers to pay for goods or services after they have been supplied
• Interest on trade credit 


  No explicit interest, however explicit discounts for not using trade credit
• Why would business pay later than their credit terms

  Free finance. Suppliers devote resources to chasing late payers-damage relationship w suppliers
• Non recourse factoring 


  The supplier sells its trade debts to a factor in order to obtain cash payment of the accounts before their actual due dates