4. Short-Term (Working Capital) Financing Flashcards

1
Q

What is financial structure?

A

The mix of liabilities (LT and ST) and owner’s equity accounts of a firm.
Financial structure includes capital structure.

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2
Q

What is capital structure?

A

The long-term sources of funding (LT debt and owners’ equity).

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3
Q

What is short-term financing? What is it also called?

A

The funding provided by obligations which become due within one year (i.g. current liability).
Also called working capital.

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4
Q

Short-term financing: What are examples of primary forms?

A

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.

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5
Q

Payables: what is it?

A

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.

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6
Q

Payables: what is the item widely used?

A

Trade accounts payables.

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7
Q

Payables: What are advantages of trade accounts payable?

A
  • 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
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8
Q

Payables: What are disadvantages of trade accounts payable?

A
  • 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
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9
Q

What is the annual percentage rate (APR) for;

2/10, n/30?

A
APR = [(discount lost / principal) x 1] / Time fraction of year.
APR = [(.02/.98) x 1] / (20/360) = 36.73%
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10
Q

Payables: What is Accrued accounts payable?

A

Results from acquiring cash and other benefits financed by an obligation to be satisfied in the future.

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11
Q

Payables: Examples of accrued accounts payable?

A
  • 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.
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12
Q

Payables: Accrued accounts payable: Advantages?

A
  • 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.
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13
Q

Payables: Accrued accounts payable: Disadvantages?

A
  • Required pmt in the short-term

* Some financing is use specific; many things can’t be financed through accrued account.

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14
Q

Payables: What is short-term notes payable?

A

Result from acquiring cash through borrowing with repayment due in one year or less.

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15
Q

Payables: What are characteristics of ST notes payables?

A
  • Typically a promissory note is required
  • Interest rate charged is based on credit rating of borrower
  • A compensating balance may be required
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16
Q

Payables: What is compensating balance? How does it affect effective cost of borrowing?

A

An amount that must be maintained in a demand deposit account with lender.
It increases effective cost of borrowing.

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17
Q

Payables: ST notes payable: Advantages?

A
  • 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
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18
Q

Payables: ST notes payable: Disadvantages?

A
  • 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
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19
Q

Payables: Cost of borrowing and effective interest rate: EX:

Borrowed $20,000, one-year, 6% interest, 10% compensating balance.

A

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%

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20
Q

Standby Credit and Commercial Paper: What is standby credit?

A

An arrangement to have financing available for a specific purpose or period of time.

21
Q

Standby Credit and Commercial Paper: What are 3 forms of standby credit?

A
  • Line of credit
  • Revolving credit
  • Letter of credit
22
Q

Standby Credit and Commercial Paper: What is line of credit?

A

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
23
Q

Standby Credit and Commercial Paper: What is revolving credit?

A

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

24
Q

Standby Credit and Commercial Paper: What is letter of credit?

A

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
25
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
26
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
27
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
28
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
29
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)
30
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
31
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
32
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
33
Receivables/Inventory: What is factoring?
The sale of A/R.
34
Receivables/Inventory: Factoring: what is buyer called?
Factor
35
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.
36
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
37
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
38
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
39
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.
40
Receivables/Inventory: Inventory secured loan: How is the amount that can be borrowed determined?
Depends on value and marketability of the inventory.
41
Receivables/Inventory: Inventory secured loan: What are arrangements?
* Floating lien agreement * Chattel mortgage agreement * Field warehouse agreement * Terminal warehouse agreement
42
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.
43
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.
44
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
45
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
46
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
47
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
48
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