SHORT TERM FINANCING

• Spontaneous sources


  Trade credit (accounts payable)

  Accruals (accrued expenses)

  Deferred income
• Negotiated sources


  Commercial bank loans

  Commercial paper
• Trade credit (accounts payable)


  Considered a spontaneous financing because it is automatically obtained when a firm purchases goods or services on credit from a supplier

  A continuous source of financing

  More readily available than other negotiated sources of short-term credit
• Cost of trade credit


  Trade credit usually bears no interest, but it is not costless

  Its cost is implicit in the terms of credit agreed upon (the discount policy and the credit period)
• Calculating annual rate for trade credit


  Annual rate = (Interest cost per period x number of days in a year) / (Usable loan amount x number of days funds are used)

  = (Discount% x 360 days) / (100% - Discount% x Net period* - discount period)
• Accruals (accrued expenses)


  Another form of spontaneous financing, which represent liabilities for services that have been provided to the company but have not yet been paid for

  Typical examples: accrued wages, salaries, rent and taxes, interest

  Cost of accruals: none, whether implicit or explicit cost
• Deferred income


  Customers' advance payments or deposit for goods or services that will be delivered at some future date

  Cost of deferred income: None
• Commercial bank loans


  Short-term business credit provided by commercial banks, requiring the borrower to sign a promissory note to acknowledge the amount of debt, maturity and interest
• Cost of bank loans


  Regular interest rate = Interest / Borrowed amount

  Discounted interest rate = Interest / (Borrowed amount - interest)

  Effective interest rate = Interest / Usable loan amount (loan amount - discount interest - compensating balance)
• Commercial paper


  Short-term, unsecured promissory notes (IOUs) issued by large firms with great financial strength and high credit rating to other companies and institutional investors, such as trust funds, banks, and insurance companies

  Entails lower cost than bank financing (the interest rate is usually lower than the prime rate)

  Disadvantage: limited access and availability; only the largest firms with the greatest financial strength can issue commercial papers; the amount of funds available is limited to the excess liquidity of big corporations
• Cost of commercial paper


  Effective annual interest rate = (Interest cost per period + transaction cost) x (number of days in a year / (Usable loan amount x number of days funds are borrowed))
• Line of credit: The bank agrees to lend up to a maximum amount of credits to a firm; applicable to firms that need frequent funding in varying amounts.
• Revolving credit agreement

  • The bank makes a formal, contractual commitment to provide the maximum amount to a firm.
  • the firm pays a minimal commitment fee per year on the average unused portion of the commitment.
• Transaction loan (single payment loan)

  • short-term credit for a specific purpose
• Cost of Trade Discount

  No trade discount (no cash discount): Purchases on credit without trade discount are usually priced higher than cash purchases; The difference between the selling prices is the implicit cost of credit.
• cost of trade discount

  with trade discount (with cash discount): If a supplier allows a trade discount for prompt payment, an implicit cost is incurred if the discount is not availed of
• full capacity sales = actual sales / % of capacity at which FA are operated
• target FA to sales ratio = actual FA / full capacity sales
• required level of FA = target FA to sales ratio x projected sales