Short-Term Financing: Understanding Spontaneous and Negotiated Methods, Summaries of Finance

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Chapter 11 Chapter 11

Short-Term Short-Term

Financing Financing

Short-Term Short-Term

Financing Financing

Instructor: Syed Irfan Shah BukhariSyed Irfan Shah Bukhari

Short-Term Financing Short-Term Financing

Spontaneous Financing

Negotiated Financing

Factoring Accounts Receivable

Composition of Short-Term Financing

Spontaneous Financing Spontaneous 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:

Spontaneous Financing Spontaneous Financing

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.

Terms of the Sale Terms of the Sale

 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.

Trade Credit as a Trade Credit as a

Means of Financing Means of Financing

$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!!

Cost to Forgo a Discount Cost to Forgo a Discount

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

Cost to Forgo a Discount Cost to Forgo a Discount

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 ____.”.”

Advantages of Advantages of

Trade Credit Trade Credit

 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.

Who Bears the Cost of Who Bears the Cost of

Funds for Trade Credit? Funds for 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.

Spontaneous Financing Spontaneous Financing

 Money Market CreditMoney Market Credit  Commercial Paper  Bankers’ Acceptances  Unsecured LoansUnsecured Loans  Line of Credit  Revolving Credit Agreement  Transaction Loan

Types of negotiated financing Types of negotiated financing:

“ “Stand-Alone”Stand-Alone”

Commercial Paper Commercial Paper

 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).

Bankers’ Acceptances Bankers’ Acceptances

 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.

Short-Term Short-Term

Business Loans Business Loans

 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.