KCB WEEK 6 - Sources of short-term financing Flashcards
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Main sources of short-term financing?
External
* Overdrafts
* Bills of exchange
* Invoice discounting
* Factoring
* New(er) developments
Internal
* Reduction of working capital
* Sale of redundant (non-current) assets
* Retained profits
Advantages and disadvantages of overdrafts
Advantages
* Easy
* Immediate access
* Can be reduced anytime if surplus cash available
* Usually not included in calculation of capital gearing
* Interest payments are tax deductable – cost of borrowing goes down
* Usually not included in calculation of (capital) gearing (uses non-current liabilities)
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Disadvantages
* Rate of interest linked to LIBOR – London Interbank Offer Rate (banks interest rate for lending to one another) – not predictable
* Banks charge higher interest than LIBOR when lending to external
* May need to offer a security
* Banks charge annual fee on top of interest – possible one off fee for setup
* Risky - as is repayable on demand
Details on / what is invoice discounting
o Company selling on discount – seller borrows from invoice discounter / bank using invoice to customer as collateral
o Uses discount factoring to calculate present value
o Up to 80% of amount receivable immediately
o Bank/discounter will give net amount
o Total less interest of time receivable from total
o But can be used to finance next trade
o Risk - customer can’t pay/company can’t settle if something goes wrong
o Invoice kept – after time period – send to customer and explain are supplier but have sold invoice and customer should settle full amount with the invoice discounter (or bank) – 80% and interest on it are deducted and then fee deducted – balance given to the company (once settled by customer)
o Shouldn’t take just all/any invoice – use a reputable customer – discounter/bank will recognise the name and accept.
o Should take an invoice which makes sense re what you need for next trade in terms of finance
Open vs Closed invoice discounting
o Open (disclosed) discount invoicing customer will know invoice sold, won’t mind – some will mind and could change their supplier who can fund from their own financing rather than selling to invoice discounter – can choose closed (undisclosed) invoice discounting . This works the same way but company will send invoice as normal at end of credit period and customer won’t know debt is sold.
Advantages and disadvantages of discount invoice discounting
Advantages
* Quick method to give trade finance
* Doesn’t need separate collateral – invoice itself serves as such
* Seller can finance working capital needed for other sales transactions
* Buyer gets interest free credit period
* If necessary- discounting of bill need not be disclosed to customer
* Cheaper than offering cash details
Disadvantages
* Fees charged by discounter reduce profit margin
* Some customers may be uneasy when their bills are discounted with an external party
* Not all invoices meet standard for ‘discount-grade’ bill (
* Over reliance may create poor imagine of seller in trade circles
Factoring
o Comes from invoice discounting – ‘whole sale invoice discounting’
o Usually bank will provide – sometimes auditors
o Instead of individual, takeover ALL claims on customer – send a copy each time the customer is billed
Ex. need £400k for next trade take invoice of £500k, 80% given – need to find a bill which is suitable level – the bill then also must be discount-grade
o Business sells all/selected amount of its receivables as a ‘factor’
o Factor advances around 80% of total value of outstanding invoices
o At end of credit period – money collected by customer by the
Factor (disclosed factoring)- then fwds the balance after deducting a fee
Seller (undisclosed factoring) who sends the advance to the factor adding the fee
WITH (factor asks seller if customer fails for reimbursement) AND WITHOUT RESOURCES (if customer proves to be a bad debt FACTOR WILL BEAR LOSS) – usually ask seller before approving new credit to get additional credit/charge higher fee to avoid
Advantages and disadvantages of factoring
Advantages
* Immediate access to funds
* Credit control expertise of the factor will be useful in avoiding bad debts
* Can be arranged by a number of organisations
* Other lines of credit are not affected because factoring is not shown in the SOFP or included in gearing – other creditors won’t know about extent of factors
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Disadvantages
* Not cheap
* May not be viewed favourably by ll customers
* Recourse-factoring : risk of bad debt is borne by the company
* Control of customers is lost without recourse factoring
Overview - new developments in short-term financing
o Crowd funding
Web-based platform
Via internet
Usually offer higher return to investors than other investment opps
May not be suitable for large investments
Associated with high risk
o Peer to peer lending
o Invoice trading third party payment platforms
Advantages and disadvantages of ‘new developments’
Advantages
* Quick access to funds
* Borrowers and lenders connected via the internet
* Can be arranged according to finance needs of borrower
* Borrower can avoid unnecessary financial distress
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Disadvantages
* High risk often associated with new types of finance
* Expensive from borrowers point of view
* Not suitable for large sums
* Market is still evolving and not all the associated risks are known (court cases needed to lay down guidelines for future cases/for parliament to set future legislations re disputes in court)
Reduction of working capital (internal source of short-term financing) overview - advantages and disadvantages
1) Reduction of inventory levels
ADV: Reduce stock holding costs (ex RENT/utilities/assoc. wages)
Minimise obsolescence and damage
Free up money opportunity cost (of carrying inventory). Recommended.
DISADV: Risk of stock-out situation
Loss of production time
Quantity discounts may be lose
Inventory + receivables – payables = amount invested in working capital
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2) Tightening of credit control
ADV: Frees up capital
Bad debts reduced
Cost of credit control decreased
Reduces opportunity cost
DISADV: Loss of customers
Reduced sales
Profit loss due to reduced sales
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3) Delaying payments to suppliers
ADV: Improves short term cash-flow
Usually no interest on delayed period
Reduces own working capital finance
DISADV: Cannot be used for a long time
Suppliers may refuse credit facility for future purposes
Loss of reputation
Sale of redundant non-current assets (internal source of shor-term financing) - advantages and disadvantages
Advantages
* Frees up capital from an unused asset
* Does not dilute ownership control
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Disadvantages:
* An asset may not be readily available for sale
* A one off event
* Takes time to find a buyer
* Matching the required amount & the sale value of asset is difficult
Retained profits as a source of internal short-term financing
Can be used as and when it is needed (per balance sheet)
Also has a cost (2 WEEKS WHEN LOOKING AT COST OF CAPITAL)
