Short Term Funds Flashcards
Consist of all current liabilities
Terms may range from monthly to upto a year
Short-Term Funds
Are numerous and range from the time spontaneous accounts payable are reconized on trade credits.
Part of working capital used by the firm in its normal operating cycle
Current Liabilities
Advantages of Short-term funds
- Easy to obtain and arrange
- Interest rate is lower due to lower risk
- Is more flexible for the borrower
Disadvantages of Short-term funds
- Interest rates are too volatile (Unstable)
- Frequent refinancing is needed
- Credit standing changes easily
What are the 9 sources of Short-term Funds?
- Trade Credit
- Stretching Payables
- Accruals
- Bank Loans
- Banker’s Acceptances
- Finance Company Loans
- Commercial Financing
- Receivable Financing
- Inventory Financing
Is the cheapest way of obtainig a short-term loan and considered to be the largest source of short-term funds.
Trade Credit
What are the two parties that are composd in Trade Credit?
Buyer and Seller
Involves paying the obligations later than what is expected.
The payer simply ignores the due date of the obligation.
Helps the company ro reduce cost of the discount and increases its accounts payable balance.
Stretching Payables
Are expenses already incurred but not yet paid for by the company.
Some if these expenses are salaries and wages, taxes, and interest.
Accruals
These are compensations given to employees.
These are not paid daily, thus they accumulate
Salaries and Wages
These are loans secured from banks that are payable within 1 year
Short-Term Bank Loans
This document serves as proof of acceptance that the company has an obligation to the bank to pay the principal and interest when the loan matures.
Promissory Note
How can bank loans be payed on?
Maturity Dates or Installments
When are interest of short-term bank loans collected?
Either advanced or at the end of the term
Recite the loan process.
- The borrower submits a loan application to the account officer.
- The account officer evaluates the loan’s feasibility.
- If feasible, terms, conditions, and required documents are outlined.
- The account officer processes the loan with all necessary requirements.
- The loan application is presented to the loan-deciding body for approval.
- Upon approval, a promissory note is signed to signify indebtedness.
- The loan is released to the borrower’s account or through a manager’s check.
What are the two types of loans?
Secured and Unsecured Loans
What are reasons for taking bank loans?
- Covering Costs for purchased goods.
- Taking advantage of cash discounts from sellers.
- Funding daily operating activities.
- Making downpayments for fixed asset acquisition.
- Reserving cash for unforseen expenses.
- Meeting cash dividend payments.
What are the Terms and Conditions of Bank Loans?
- Fees and charges
- interest rates, penalties and credit limits.
- Collateral requirements
- Amortization and payment details
Is a loan that is backed by collateral, reducing the bank’s risk.
The bank may repossess the pledged asset if borrower defaults.
includes real estate, equipment, stocks and inventory
Secured
Not backed by collateral, carrying higher interest rates and posing a greater risk for lenders.
These loans are more challenging to obtain
Unsecured
What are the three types of Bank Financing?
- Line Credit
- Revolving Credit Line
- Installment Loan
This is a loan granted preiodically, often renewed annually based on the borrower’s credit standing.
Allows borrowing up to a specified limit.
Can be repaid flexibly, though a compensating balance may be required.
Line Credit
This is a loan similar to a line credit, but the credit replenishes once repaid.
Functions like a credit card
Offers flexibility for daily operational needs, it may incur fees on unused portions.
Revolving Credit Line
This is a loan repaid in regular intervals (monthly,quarterly, semi-annually), combing principal and interest.
Installment Loan
What are two ways to calculate installment loans?
Straight Line & Scientific
This installment method follows a fixed principal payment every period. It is calculated by getting the quotient of the principal and the number of payment periods.
Total x (Interest / Term)
Straight Line Method
This installment method is where the total payment per period is equal. The principant payment is obtained by deducting the interest from the total payment.
Total Loan = Periodic payment x [1 - (1+i)^-n/i]
Scientific Method
It is the minimum balance required by banks in a borrower’s current or savings account before granting credit .
This balance, along with interest charges, increases the effective interest rate for the borrower .
Amount to be borrowed = Amount needed / (1-c)
c= Compenstating Balance
Compensating Balance
It is the amount charged to the borrower for the use of funds. can vary based on factors such as the loan. Amount, competition among banks, the firm’s financial health and the purpose of the loan.
Interest Rate
Clients with banking relationship typically receive lower interest rates than those without
What are the 2 types of charged interest rates?
Fixed Interest Rate & Floating Interest Rate
It is constant rate of interest that does not change with fluctuations in the prime interest rate.
Fixed interest rate
It is a variable interest rate that adjust according to changes in the prime rate.
Floating interest rate
What are the two types of interest charging?
Add-on Interest & Discount Interest
This method calculates interest based on the outstanding balance, with the computed interest added to the principal payment.
Add-on Interest
In this method, interest is deducted form the loan amount at the time of disbursement, resulting in proceeds that are lower than the loan’s face value .
Discounted Interest
It is the charge given to the borrower
and is calculated by getting the quotient of the amount of
interest paid and principal amount borrowed
Effective Interest Rate
Definition: A time draft or bill of exchange that a bank guarantees to pay at a future date. The bank “accepts” liability.
Used for: Short-term credit instrument for financing international trade or imports/exports.
Payment: Payment is deferred to a future date (maturity), allowing time for goods to be shipped and received.
Guarantee: The bank guarantees payment by “accepting” the draft, becoming responsible for payment at maturity.
Discounting: Can be discounted on the secondary market before maturity, giving immediate cash to the holder.
Participants: Involves the buyer, seller, and accepting bank (or accepting financial institution).
Risk Reduction: Reduces risk for the seller, as the bank guarantees payment at maturity.
Use by Importers: Used by importers seeking short-term financing, allowing them to defer payment until goods are received or sold.
Banker’s Acceptance
Definition: A bank’s promise to pay the seller on behalf of the buyer, provided that the seller meets specific conditions.
Used for: Primarily used to guarantee payment to exporters for goods/services provided, upon presentation of required documents.
Payment: Payment is made upon presentation of required documents, typically upon shipment or upon receipt of goods.
Guarantee: The bank guarantees payment if the seller meets all conditions specified in the letter of credit.
Discounting: Cannot be directly discounted, but can be monetized if confirmed or if specific provisions for discounting exist.
Participants: Involves the buyer, seller, issuing bank, and often a confirming bank (in the case of confirmed L/C).
Risk Reduction: Reduces risk for both buyer and seller, as payment is guaranteed if terms are met.
Use in International Trade: Used by exporters and importers to ensure secure transactions, especially in international trade.
Letter Credit
What is the process of Letter of Credit
- Sale contact
- SBLC Opening Request
- Issuing SBLC
- SBLC Advicing & Confirming
- Goods Delivery
These are loans provided by non-bank financial institutions to businesses, often secured by assets like accounts receivable, inventory, or equipment. They are a form of financing used by businesses to fund their operations or growth.
Commercial Finance Company Loans
It is a short-term, unsecured debt instrument issued by large corporations to raise funds for immediate financial needs, such as working capital, inventory purchases, or other short-term expenses. It is typically issued at a discount and has a maturity of less than 270 days (9 months).
Typically has a lower interest rate compared to banks
Only those who got right credit ratings can issue this
Commercial Paper
This can be offered as a collateral, allowing companies to access cash based on their current receivables when there is cash shortages due to delayed collections of credit sales.
Receivable Financing
What are the main forms of Receivable Financing?
- Pledging of Accounts Receivable
- Factoring of Accounts Receivable
- Assignment of Accounts Receivable
- Discounting of Promissory Notes
Description: This involves using receivables as loan collateral without notifying customers.
Ownership: The firm retains ownership and remains responsible for collecting receivables.
Loan Value: The loan value depends on the firm’s credit rating.
Pledging of Accounts Receivable
Description: The borrower assigns accounts receivable to a creditor as collateral, formalized through a security agreement (Deed of Assignment).
Notification: It can be done on a notification or non-notification basis.
Responsibility: The borrower continues to collect receivables, while the assignee provides cash advances based on the quality of the accounts, charging commissions and fees.
Assignment of Accounts Receivable:
Description: This is the outright sale of accounts receivable to a financing company (factor) on a without recourse basis.
Responsibility: The factor assumes responsibility for collections and, in case of non-collection, cannot reclaim funds from the selling company.
Costs: The costs are typically higher due to credit risk.
Factoring of Accounts Receivable:
Description: A promissory note is a written promise to pay a specified sum either on demand or at a future date. It can be sold at a discount to a bank or lending agency.
Key Features:
- Face value, date, maturity date, interest rate, creditor, and debtor.
- The net proceeds are the face value minus the discount, based on the days until maturity from the discounting date.
Discounting of Promissory Notes:
Promissory Note Features
It is the amount of loan to be paid on maturity date.
Face Value
Promissory Note Features
It is the date when the note is written.
Date of Note
Promissory Note Features
It is the date of paymnet as agreed by the borrower and the lender.
Maturity Date
Promissory Note Features
It is the charge for borrowing.
Interest Rate
Promissory Note Features
It indicates the one who accepts the note and to whom payment is to be made
Creditor
Promissory Note Features
It indicates the borrower who signs the note.
Debtor
Purpose: Used when a firm lacks other forms of collateral for a loan.
Requirements for Viability:
- Marketability: The inventory must be easy to sell.
- Price Stability: The inventory should have stable marketing prices.
- Non-perishable: The inventory should not be perishable.
Considerations:
Firms must consider the potential difficulties and costs involved in selling the inventory to recover the loan if needed.
Inventory Financing
What are the 3 types of Inventory Financing?
- Floating Lien
- Warehouse Lien
- Trust Receipt
Inventory Financing
Definition: Allows the creditor to claim the entire inventory without specifying individual items.
Borrower’s Control: The borrowing firm retains control over the inventory.
Identification: Specific identification of inventory items is unnecessary for obtaining the loan.
Also known as a blanket lien
Floating Lien
Inventory Financing
Description: Specific goods are segregated and stored at a public warehouse.
Debtor’s Action: The debtor instructs the warehouse to issue a receipt to the creditor, confirming custody of the collateral.
Creditor’s Protection: The receipt protects the creditor, allowing access to the inventory only upon proper authorization.
Warehouse Lien
Inventory Financing
Creditor’s Rights: The creditor retains the title to the inventory.
Debtor’s Use: The debtor is allowed to use the inventory for production or sales.
Proceeds: The debtor must remit the proceeds immediately.
Inventory Identification: The collateral inventory is specifically identified, often through serial numbers.
Common Usage: This type of financing is common among importers of goods and raw materials.
Trust Receipt
