Finance - Source of Financing - Debt and non-equity

Question 1

Explain what short-term financing is

Answer 1

Short-term financing - Source that must be repaid within 12 month’s period. Providing additional money for business requires

Question 2

Explain how trade credit is used and the formula for effective annual interest rate

Answer 2

Trade credit - refers to deferred payment terms granted by the supplier
- Depending on these factors, credit terms (30 days to 90 days) can be arranged
- The company should maximize its use of this source of financing but not to the point company credit rating the relationship

Effective annual interest rate = (1+ (Cash discount/ Price- cash discount) ^(365/extra days) - 1

Line of credit - allows a company to receive money from a bank up to a specified limit and will have to pay back the principal + interest

Question 3

Explain what customer advances are and what Line of credit facility

Answer 3

Customer advances - is an alternative form of financing wherein a seller requires advance payment from its customer for its goods or service

Line of credit facility - Bank - arrangement whereby the banks allow the borrower to withdraw money up to the specified limit
Shareholder guarantee - on PPE may also be required where general security of assets
Margin limit - is the % of the value of the asset that is used as security for the loan that can be advanced

Standby fee - typically amount to advance up to the total amount of the facility
*Important bank financing is covenant restriction

Question 4

Explain what a demand loan is and factoring

Answer 4

Demand loan - traditional loan in that they set amount and essentially due on demand
* Can require immediate payment

Factoring - sales of specific outstanding receivable for cash proceeds less a fee for specialist finance

Feature of short-term financing: Amount, Cost before and after taxes, Term (maturity), obligatory payment, Financial reporting impact

Question 5

Explain what is long-term loan

Answer 5

Long-term loans and non-equity - can originate from many different sources, including bank institutions
Long term loan and bonds is unique with specified terms - maturity date, interest rate, security, covenant, specific condition

Question 6

What is the difference between senior and junior debt for term loans

Answer 6

Senior debt - securities have been claimed before junior debt
Junior debt - will rank before any equity claims

Question 7

Explain some terms that are too occur in long term loans

Answer 7

1. Amount - Depends on the company’s ability to repay interest & principal payment
2. Terms - normally uses can be up to 50 years or in perpetuity. Long term asset, equipment, intangible asset
3. Interest rates - are set to compensate the lender for risk associated with the loan. Depends on the creditor or can be fixed or floating
4. Collateral - unsecured loan - no collateral
   Secured loan - in the form asset pledged to the borrower to support the loan until repaid

Question 8

What is zero coupon bonds and government assistance

Answer 8

Zero-coupon bonds - bonds are used at a discount and the principal is repaid at maturity
- Does not make cash payment throughout the term of the bond, either interest or principal

Government assistance - The government provides various sources of financing such as grants, loans, subsidiaries, and loan
- Monies received that do not need to be repaid as long as conditions are met
- Advan: unsecured & requires no covenant
- Disadvan: Need to detect the requirement if not will need to repay the loans

Stakeholder objective - Long-term financing decisions should be consistent with decisions about entity’s capital structure
- Govn’t assistance often attractive form of financing
- Long term financial increase risk of existing shareholder

Question 9

What is asset-based financing

Answer 9

• It is a loan structure by securing assets.
• Understanding asset value

First charge - Lender will have first claim on the security of default
- Determine the maximum amount to advance an assessment
- Asset-based loans may have fewer covenants and lender may be able to advance

Question 10

What are two forms of asset-based financing

Answer 10

1. Securitization - are complex financial transaction whereby a new security instrument is designed by a pool of cash-generated assets owned by the company
   - Ex. A/R, credit card receivables, loan receivable, mortgage receivable
   - Depending on the nature of the agreement between the company and the issuer, the form of financing may to may not be reported
2. Factoring - Companies obtain credit from their supplier, they often give credit to their customer, creating accounts receivable
   - Specialized finance form pay amount due to the company upfront and take responsibility for collecting A/R balance