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An in-depth analysis of short-term financing, focusing on spontaneous financing through accounts payable and terms of sale, and negotiated financing through commercial paper, bankers' acceptances, and unsecured loans. Learn about the advantages and disadvantages of trade credit, the role of buyers, both, suppliers, and taxes in funding trade credit, and the costs of borrowing.
Typology: Summaries
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Instructor: Syed Irfan Shah BukhariSyed Irfan Shah Bukhari
Spontaneous Financing
Negotiated Financing
Factoring Accounts Receivable
Composition of Short-Term Financing
Open Accounts : the seller ships goods to the buyer with an invoice specifying goods shipped, total amount due, and terms of the sale 2%/10, n= Notes Payable : the buyer signs a note that evidences a debt to the seller. Trade Credit B2B Trade Credit B2B--credit granted from one business to another. Examples of trade credittrade credit are:
Draft Draft -- A signed, written order by which the first party (drawer) instructs a second party (drawee) to pay a specified amount of money to a third party (payee). The drawer and payee are often one and the same. Trade Acceptances : the seller draws a draftdraft on the buyer that orders the buyer to pay the draft at some future time period.
Seasonal DatingSeasonal Dating -- credit terms that encourage the buyer of seasonal products to take delivery before the peak sales period and to defer payment until after the peak sales period. Net Period - Cash DiscountNet Period - Cash Discount -- when credit is extended, the seller specifies the period of time allowed for payment and offers a cash discount if paid in the early part of the period. “2/10, net 30” implies full payment within 30 days from the invoice date less a 2% discount if paid within 10 days.
$1,000 x 30 days = $30,000 account balance What happens to accounts payable if a What happens to accounts payable if a firm purchases $1,000/day at “net 30”? firm purchases $1,000/day at “net 30”? What happens to accounts payable if a What happens to accounts payable if a firm purchases $1,500/day at “net 30”? firm purchases $1,500/day at “net 30”? $1,500 x 30 days = $45,000 account balance A $15,000 increase from operations A $15,000 increase from operations!!
Approximate annual interest cost = 2% 365 days (100% - 2%) (30 days - 10 days) = (2/98) x (365/20) = 37.2% What is the approximate annual cost to What is the approximate annual cost to forgo the cash discount of “2/10, net 30,” forgo the cash discount of “2/10, net 30,” and pay at the end of the credit period? and pay at the end of the credit period? X
Payment Date* Payment Date* Annual rate of interestAnnual rate of interest 11 744.9% 20 74. 3030 37.237. 60 14. 90 9.3* days from invoice date
The approximate interest cost over a The approximate interest cost over a variety of payment decisions for variety of payment decisions for “ “2/10, net ____2/10, net ____.”.”
Convenience and availability of trade credit Greater flexibility as a means of financing Compare costs of forgoing a possible Compare costs of forgoing a possible cash discount against the advantages cash discount against the advantages of trade credit. of trade credit.
BuyersBuyers -- when costs can be fully passed on through higher prices to the buyer by the seller. BothBoth -- when costs can partially be passed on to buyers by sellers. SuppliersSuppliers -- when trade costs cannot be passed on to buyers because of price competition and demand.
Money Market CreditMoney Market Credit Commercial Paper Bankers’ Acceptances Unsecured LoansUnsecured Loans Line of Credit Revolving Credit Agreement Transaction Loan
Commercial paper market is composed ofCommercial paper market is composed of the the (1) dealer and (2) direct-placement markets. AdvantageAdvantage: Cheaper than a short-term business loan from a commercial bank. Dealers require a line of creditline of credit to ensure that the commercial paper is paid off. Commercial Paper Commercial Paper -- Short-term, unsecured promissory notes, generally issued by large corporations (unsecured corporate IOUs).
Used to facilitate foreign trade or the shipment of certain marketable goods. Liquid market provides rates similar to commercial paper rates. Bankers’ Acceptances Bankers’ Acceptances -- Short-term promissory trade notes for which a bank (by having “accepted” them) promises to pay the holder the face amount at maturity.
Secured LoansSecured Loans -- A form of debt for money borrowed in which specific assets have been pledged to guarantee payment. Unsecured LoansUnsecured Loans -- A form of debt for money borrowed that is not backed by the pledge of specific assets.