Chapter 5: Sources and Uses of Short-Term Funds

Question 1

Short-term funds primarily include (?):

Answer 1

Current Liabilities (Short-term Debt)

Question 2

Short-term funds are crucial for:

Answer 2

Firm’s Working Capital (supporting daily operations and the operating cycle).

Question 3

Advantages of Short-term Funds include:

Answer 3

1. Easy to obtain and arrange; exposure of the financial institutions granting the loan is shorter and has less risks.
2. The interest rate is lower; financial institution has lower risk in terms of the collection period.
3. More flexibility on the borrower.

Question 4

Disadvantages of Short-term Funds include:

Answer 4

1. Interest rates are too volatile.
2. Frequent refinancing is needed.
3. Credit standing changes easily.

Question 5

Sources of Short-Term Funds include:

Answer 5

• Trade Credit
• Stretching of Payables
• Accruals
• Bank Loans
• Banker’s Acceptance
• Finance Company Loans
• Commercial Paper
• Receivable Financing
• Inventory Financing

Question 6

An agreement where suppliers extend credit for purchases, commonly reflected as accounts payable.

Answer 6

Trade Credit

Question 7

It’s often the most cost-effective short-term funding source and may offer discounts if paid within a certain period.

Answer 7

Trade Credit

Question 8

Average Accounts Payable Formula =

Answer 8

(Annual Purchase / 360) (Credit Period)

Question 9

Cost of Discount Foregone Formula =

Answer 9

(Discount % / 100% - Discount %) (365 / Final Due Date - Discount Period)

Question 10

Delaying payments beyond the due date; may reduce discount costs and increase payable balances.

Answer 10

Stretching of Payables

Question 11

Expenses incurred but not yet paid, such as wages, taxes and interest. These allow companies to use cash for other purposes temporarily.

Answer 11

Accruals

Question 11

Common Examples of Accruals include:

Answer 11

1. Salaries and Wages
2. Taxes
3. Accrued Interest

Question 12

Granted by banks, often requiring a promissory note. Companies may use this to cover various operational and unexpected expenses.

Answer 12

Short-Term Bank Loans

Question 13

Reasons for Borrowing include:

Answer 13

• Covering costs for purchased goods.
• Taking advantage of cash discounts from sellers.
• Funding daily operating activities.
• Making down payments for fixed asset acquisition.
• Reserving cash for unforeseen expenses.
• Meeting cash dividend payments.

Question 14

The Loan Process is as follows:

Answer 14

1. The borrower submits loan application to a bank’s account officer.
2. The officer evaluates the loan’s feasibility and outlines terms, conditions and required documentation.
3. If accepted, the officer processes the application and presents it to the loan decision-making body for approval.
4. Upon approval, a promissory note is signed, and the loan is either credited to the borrower’s account or issued as a manager’s check.