Chapter 6 - Short and medium-term finance Flashcards
List 4 forms of medium-term finance
- Bank loan
- Hire purchase
- Credit sale
- Lease
Hire purchase agreements, credit sales and lease agreements all involve a series of payments being made for an asset. Describe how these three financing methods differ in respect of the ownership of the asset.
HP – Ownership transfers at end of agreement
Credit Sales – Ownership transfers at start
Lease agreement – Ownership is not transferred
Describe hire purchase arrangements
- A series of regular (usually fixed) payments are made to another company.
- While the payments are being made, the goods are being hired.
- Legal ownership is passed to the buyer when the final payment is made.
- If the buyer fails to make the payments due under the hire purchase agreement, the seller can take back the goods.
Describe a credit sale
- The ownership is passed over to the buyer at outset.
- Regular (normally fixed) payments are made to the seller for an agreed time period.
- If the buyer fails to pay, the seller may have to sue for payments through the courts as with any other debt.
Describe leasing and the 2 types of lease
A lease is an agreement where the owner of an asset gives the lessee the right to use the asset over a period of time, in return for a regular series of payments. Legal ownership does not change hands. The 2 types of lease are:
Operating lease
• The lease period is less than the useful lifetime of the leased item.
• The lessee does not own the goods.
• The company leasing out the goods is taking on the risk (the owner)
Financing lease
• The lease period is roughly equal to the useful lifetime of the leased item.
• The lessee does not own the goods.
• The lessee is taking on the risk.
Describe bank loans and loan facilities
Bank loans
A bank loan is a form of medium-term borrowing where the full amount of the loan is paid into the borrowers account and the borrower undertakes to make interest payments and capital repayments on the full amount of the loan.
The interest rate is usually variable. Bank loans are usually secured on the borrower’s assets using a floating charge.
Loan facilities
A loan facility is a cross between an overdraft facility and a traditional bank loan.
The borrower can take out the loan in instalments, giving the bank a few days’ notice before each new one is taken out. Interest is only charged on the amount outstanding and repayment schedules are flexible.
Outline what is meant by a ‘syndicated’ loan.
A syndicated loan is a loan facility provided by a group of banks. Syndication is typically used when the sums to be borrowed are larger than any one bank would be happy to lend.
List 5 forms of short term finance
- Bank overdraft
- Trade credit
- Factoring
- Bills of exchange
- Commercial paper
Describe bank overdrafts
An overdraft is a form of short-term borrowing from a bank where the borrower is granted the facility to draw money out of a current account such that it becomes negative, down to an agreed limit.
The borrower pays interest only on the amount actually overdrawn. The interest charged on an overdraft will usually be higher than on a loan of equivalent amount.
Overdrafts made to companies are usually secured by a floating charge.
No explicit capital repayments are made but the bank can demand immediate repayment of the overdraft with no notice.
Describe trade credit
Trade credit is an agreement between a company and one of its suppliers to pay for goods and services after they have been supplied.
It is available from almost all suppliers to their business customers as part of the supplier’s normal terms of business.
In most cases no explicit interest is charged. In many industries, trade credit is so common that explicit discounts can be negotiated for ‘cash on delivery’.
State an advantage and a disadvantage of a company using trade credit as fully as possible
+ Trade credit facilities enable a company to obtain ‘free’ finance.
- (Over)use of trade credit can damage a company’s relationships with its suppliers
Distinguish between:
Non-recourse factoring
Recourse factoring
Non-recourse factoring:
• The factor pays the company when the goods are sold.
• The customer then pays the factor directly for the goods.
• The payment from the factor to the company will be less than the payment from the customer to the factor. This accounts for:
o Interest
o Credit risk
o Administration charges
Recourse factoring:
• The factor pays the company when the goods are sold.
• The customer then pays the company.
• The company then pays the factor.
• The payment to the factor will be more than the payment from the factor to account for:
o Interest
• The company retain the administration
Describe bills of exchange
A bill of exchange is a promise by a company to pay the bearer a fixed sum of money on a fixed date. The bill is ‘accepted’ or endorsed by an investment bank and hence it is sometimes referred to as a two-name instrument. A company might issue such a bill as payment for goods.
A bill of exchange is a tradeable instrument.
Where the endorser is an eligible bank, the bill is known as an eligible bill and is a very secure investment due to the bank’s guarantee.
Describe a commercial paper
Commercial paper is a single-name form of short-term borrowing used by large companies.
It comes in the form of bearer documents for large denominations which are issued at a discount and redeemed at par.
Commercial paper is not listed on the Stock Exchange. However, companies wishing to issue sterling commercial paper must meet certain minimum standards. Issuing companies must:
• Be listed on the London Stock Exchange
• Issue a statement to confirm that they comply with Stock Exchange requirements and that there have been no adverse changes in the company’s circumstances since the last published accounts.
