4. Short-Term (Working Capital) Financing Flashcards
What is financial structure?
The mix of liabilities (LT and ST) and owner’s equity accounts of a firm.
Financial structure includes capital structure.
What is capital structure?
The long-term sources of funding (LT debt and owners’ equity).
What is short-term financing? What is it also called?
The funding provided by obligations which become due within one year (i.g. current liability).
Also called working capital.
Short-term financing: What are examples of primary forms?
Trade accounts payable.
Accrued accounts payable (e.g. wages, taxes, etc).
Short-term notes payable.
Lines of credit, revolving credit and letters of credit.
Commercial paper.
Pledging and factoring accounts receivable.
Inventory secured loans.
Payables: what is it?
Occur through the acquiring of goods/services financed by incurring an obligation to pay in the future.
Financing of certain assets (supplies, inventory etc) is highly flexible; liability occurs concurrent with the acquisition of goods/services.
Payables: what is the item widely used?
Trade accounts payables.
Payables: What are advantages of trade accounts payable?
- Easy to use; little legal documentation required
- Flexible; they expand and contract with needs (i.e. purchases)
- Interest normally is not charged
- Collateral normally not required; they are unsecured
- Discounts often are offered for early pmt
Payables: What are disadvantages of trade accounts payable?
- Require pmt in the short-term
- The effective cost is higher if discounts are not taken
- Financing they provide is use specific - their use finances only the assets acquired through trade accounts
What is the annual percentage rate (APR) for;
2/10, n/30?
APR = [(discount lost / principal) x 1] / Time fraction of year. APR = [(.02/.98) x 1] / (20/360) = 36.73%
Payables: What is Accrued accounts payable?
Results from acquiring cash and other benefits financed by an obligation to be satisfied in the future.
Payables: Examples of accrued accounts payable?
- Salaries and wages payable.
- Taxes payable.
- Unearned revenue, including gift and other prepaid cards - The time between when the benefit or cash is received and the obligation is satisfied provides short-term financing.
Payables: Accrued accounts payable: Advantages?
- Easy to use; occur in the normal course of business
- Flexible; they expand/contract with activity
- Collateral normally not required. though some creditors may have specific legal claims.
Payables: Accrued accounts payable: Disadvantages?
- Required pmt in the short-term
* Some financing is use specific; many things can’t be financed through accrued account.
Payables: What is short-term notes payable?
Result from acquiring cash through borrowing with repayment due in one year or less.
Payables: What are characteristics of ST notes payables?
- Typically a promissory note is required
- Interest rate charged is based on credit rating of borrower
- A compensating balance may be required
Payables: What is compensating balance? How does it affect effective cost of borrowing?
An amount that must be maintained in a demand deposit account with lender.
It increases effective cost of borrowing.
Payables: ST notes payable: Advantages?
- Commonly available for creditworthy firms
- Flexible; amounts and periods can be varied with needs
- Collateral normally is not required; they are unsecured
- Provides cash for various purposes
Payables: ST notes payable: Disadvantages?
- Poor credit rating will mean a higher interest rate and possibly require collateral
- Require repayment in the short term
- Compensating balance would increase the effective cost and reduce funds available
- Refinancing would be necessary, if the note can’t be paid when due
Payables: Cost of borrowing and effective interest rate: EX:
Borrowed $20,000, one-year, 6% interest, 10% compensating balance.
Cost of borrowing: 20,000 x 6% = 1,200
Net proceeds = 20,000 - (10% x 20,000) = 18,000.
Effective interest rate = 1,200/18,000 = 6.7%
Standby Credit and Commercial Paper: What is standby credit?
An arrangement to have financing available for a specific purpose or period of time.
Standby Credit and Commercial Paper: What are 3 forms of standby credit?
- Line of credit
- Revolving credit
- Letter of credit
Standby Credit and Commercial Paper: What is line of credit?
Informal agreement whereby a financial institution agrees to a maximum amount of credit that will be extended at any one time
- Not legally binding on financial institution
- Provides reasonable assurance of funds
- Available funds generally can be used for any purpose
Standby Credit and Commercial Paper: What is revolving credit?
Formal agreement whereby a financial institution or other lender agrees to a maximum amount of credit that will be extended.
*Like a line of credit, but with a legally binding agreement
Standby Credit and Commercial Paper: What is letter of credit?
A conditional commitment by a financial institution to pay a third party in accordance with specified terms and conditions.
- Example: Pmt to 3rd party upon proof of shipment of goods
- Provides 3rd party assurance of pmt without the buyer (also the borrower) having to pay in advance
- Often used in connection with foreign transactions
Standby Credit and Commercial Paper: Standby credit: advantages?
- Commonly available for creditworthy firms
- Highly flexible; credit used, and debt incurred, only when needed
- Usually no collateral required; it is unsecured
- Both line of credit and revolving credit provide cash for general use
Standby Credit and Commercial Paper: Standby credit: disadvantages?
- Poor credit rating will mean a higher interest rate and possibly require security
- Typically involves a fee
- Require satisfaction in the short term
- Required compensating balance increase effective cost and reduces funds available for use
- Line of credit not legally binding on financial institution
Standby Credit and Commercial Paper: What is commercial paper?
Short-term, unsecured promissory notes sold by large, highly-creditworthy firms.
- Most are for 180 days or less
- If more than 270 days, SEC registration is required
- May be sold directly to investors or through dealers
- May be sold on discounted bases or with interest paid over the short life of the note
Standby Credit and Commercial Paper: Commercial Paper: Advantages?
- Interest rate generally lower than other ST sources
- Large amount can be obtained
- Compensating balances are not required
- No assets need to be pledged as collateral; unsecured
- Provides cash for general use
Standby Credit and Commercial Paper: Commercial Paper: Disadvantages?
- Only available to most creditworthy firms
- Requires satisfaction in the ST, usually of a large amount
- Lacks flexibility of extension or other accommodations (as compared with bank loans)
Receivables/Inventory: What is pledging A/R? How is the level of borrowing available determined?
Using A/R as security for ST borrowing (A fee based on the value of A/R pledged is usually charged)
Level of borrowing:
*Creditworthiness of the A/R
*Level of leader’s recourse against borrower
Receivables/Inventory: Pledging A/R/: What are advantages?
- commonly available
- Flexible; as new A/R occur, they can be used as security
- compensating balances are not required
- Provides cash for general use
- Lender may provide billing and collections services, usually for a fee
Receivables/Inventory: Pledging A/R/: What are disadvantages?
- Accounts are committed to lender as security (no control)
- Cost of pledging A/R may be greater than other sources of ST financing
- Requires repayment in the short term
Receivables/Inventory: What is factoring?
The sale of A/R.
Receivables/Inventory: Factoring: what is buyer called?
Factor
Receivables/Inventory: Factoring: what are terms of sale?
- Without recourse: The factor bears the risk associated with collectibility, except in the case of fraud
- With recourse: The factor has recourse against the seller for some or all of the risk associated with uncollectibility of the receivables.
Receivables/Inventory: Factoring: what does factor charge and how is it determined?
A factor’s fee based on:
- Creditworthiness and length of maturity of the receivables
- Extent to which the factor assumes risk of uncollectibility
Receivables/Inventory: Factoring: Advantages?
- Commonly available
- Flexible; as new accounts receivables occur, they can be sold
- compensating balance is not required
- Provides cash for general use
- Buyer generally assumes billing and collection responsibilities
Receivables/Inventory: Factoring: Disadvantages?
- cost may be greater than certain other sources of ST financing
- if sold with recourse, selling firm may have an on-going risk
- sale of A/R may alienate customers
Receivables/Inventory: What is inventory secured loan?
Occur when a firm pledges all or part of its inventory as collateral for a short-term loan.
Receivables/Inventory: Inventory secured loan: How is the amount that can be borrowed determined?
Depends on value and marketability of the inventory.
Receivables/Inventory: Inventory secured loan: What are arrangements?
- Floating lien agreement
- Chattel mortgage agreement
- Field warehouse agreement
- Terminal warehouse agreement
Receivables/Inventory: Inventory secured loan: What is floating lien agreement?
Borrower gives a lien on all of its inventory, but retains control of its inventory which it continuously sells and replaces.
Receivables/Inventory: Inventory secured loan: What is chattel mortgage agreement?
Lender has a lien against specifically identified inventory, borrower retains control of that inventory, but can’t sell it without lender approval.
Receivables/Inventory: Inventory secured loan: What is field warehouse agreement?
Inventory remains at borrower’s warehouse, but under the control of an independent third party
Receivables/Inventory: Inventory secured loan: What is terminal warehouse agreement?
Inventory is moved to a public warehouse and placed under the control of an independent third party
Receivables/Inventory: Inventory secured loan: how is the cost of inventory secured loan determined?
Depends on;
Nature of inventory
Credit standing of the borrower
Specific type of security agreement used
Receivables/Inventory: Inventory secured loan: Advantages?
- Commonly available for certain inventors, including commodities, automobiles, etc
- Flexible; as new inventories become available they can become security
- May provide cash for general use
Receivables/Inventory: Inventory secured loan: Disadvantages?
- Pledged inventory may not be available when needed
- Cost of using the loan may be greater than other ST financing
- May require repayment in the short term
- Not available for certain inventories
