Chapter 14 - Short-term finance and investments Flashcards
What are the main types of short-term finance?
- Trade payables
- Factoring
- Overdrafts
- Short-term loans
- Financing exports
How are payables used as a source of short-term finance?
By delaying payment to suppliers
What are the benefits of paying suppliers late?
- Alleviate cash flow difficulties
- Cash can earn a return whilst still in the paying entity’s account
What are some potential problems when paying suppliers late?
- Loss of any settlement discount
- Could obtain poor credit rating
- Supplier may stop further supplies
- Supplier may increase future selling prices to compensate
- Could face legal action
How can receivables be used as a source of short-term finance?
- Factoring
- Invoice discounting
What is factoring?
Debts are sold to a factoring company (factor)
What 3 services does a factor offer?
- Debt collection
- Financing
- Credit insurance
What is debt collection?
Credit control department outsourced to factoring entity
What is financing?
Funds may be advanced to the company prior to debt collection
What is credit insurance?
Factor may take responsibility for irrecoverable debt
What are the main 2 sources of bank lending?
Overdraft and loans
What are the advantages of an overdraft?
- Flexibility
- Only pay for what’s used, therefore cheaper
What are the disadvantages of an overdraft?
- Repayable on demand
- May require security
- variable finance costs
What methods are available for dealing with the problems of financing exports and controlling credit risk?
- Documentary credits
- Bills of exchange
- Export factoring
- Forfaiting
What is a bill of exchange?
Binds one party to pay a fixed sum to another party on demand or at a predetermined date
What are the 2 types of bills of exchange?
- Sight draft/bill (payable immediately)
- Time draft/bill (payable at predetermined date)
What are significant characteristics of bills of exchange?
- Drawee given a period of credit before having to pay a term bill
- Drawer can obtain payment earlier than the bill’s maturity date
What does the size of the discount on the sale of a bill reflect?
Rate of interest that the buyer of the bill requires from holding the bill to maturity
What services do export factor’s provide?
- Admin of receivables ledger
- Collecting payment
- Factor finance
What is forfaiting?
Same as export factoring except seller receives 100% of the receivable as a lump sum
What are the key features of forfaiting?
- Importer obtains medium-term finance for much of the purchases cost of goods
- Exporter receives immediate payment
- Credit risk accepted by forfaiting bank
What can cash surpluses be invested into in the short term?
- Interest bearing bank accounts
- Negotiable instruments
- Short-dated gov bonds
- Other short term investments
What is the criteria used to assess short-term investments?
- Maturity
- Return
- Risk
- Liquidity
- Diversification
How long should the maturity be of a short-term investment?
Maturity should be no longer than the duration of the cash surplus
What is the target return of a short-term investment?
Interest yield
What are the 2 types of interest bearing accounts?
- Deposit accounts
- Money market deposits
When can money invested in the money market be withdrawn?
Until deposit has matured
What is the formula for interest earned?
(amount deposited x annualised interest rate x (no. of days interest earned/annual day count))
Annual day count is number of days in the year
What are negotiable instruments?
Financial instruments that may be obtained as investments
Title passes when the instrument is handed from one person to another
What are some examples of negotiable instruments?
- Bank notes
- Bearer bonds
- Certificates of deposit
- Bills of exchange
- Treasury bills
What is a Certificate of deposit (CD)?
Provides evidence of a short-term deposit with a bank for a fixed term and earning a specified amount of interest
Min deposit $100k
For how long can a CD be held?
Until maturity and can then claim money
Are CDs more or less liquid than money market deposits?
More liquid as can be sold to quickly obtain funds
How long does it take for a treasury bond to mature?
3 months (91 days)
What are the traits of treasury bills?
- High credit quality
- Low risk
- Lower yields
What are corporate bonds?
High risk long term investments
What is commercial paper (CP)?
Short-dated negotiable debt instruments issued by an entity
