SHORT-TERM FINANCING

Short-Term Financing: Funds available

for a period of one year or less is called
short-term financing. Creditors, accounts
payable, bank loan, trade credit,
commercial papers etc. are sources of
short-term financing.

Open Account: In this type of trade

credit, the buyer does not have to sign a
formal debt instrument evidencing the
amount due to the seller. The seller
extends credit based on a credit
investigation of the buyer.

There are two classes of short-term

financing:
Spontaneous sources
i) Trade credit
ii) Accruals
Negotiated sources

Trade Note Payable: When the buyer

signs a promissory note to obtain trade
credit, it shows
Up on the buyers balance sheet as a
trade note payable.
Trade
Acceptance:
Under
this
arrangement the seller draws a draft on
the buyer to pay the draft at some future
date. The seller will not release the goods
until the buyer accepts the time draft.
Accepting the draft, the buyer designates
a bank at which the draft will be paid
when it becomes due. At that time the
draft becomes a Trade Acceptance.

Spontaneous Sources: Spontaneous

sources are those sources, which arise
from the firms day-to-day operations.
The different spontaneous sources of
short-term financing are:
Trade Credit: Most of firm purchases do
not have to be paid for immediately and
this deferred of payment is a short-term
source of financing called trade credit. So
trade credit is a debt between firms
arising from credit sales between firms.
The three major items of the credit termsdue date, cash discount, and discount
rate-as usually stated as follows:
X

Credit Term: The three major items of

the credit terms due date, cash
discount, and discount rate are usually
stated as follows:
X

/Y, net Z

/Y net z

Where X is the cash discount (percent),

Y is the discount date (days), and Z is the
due date (days).

Where X is the cash discount (percent),

Y is the discount date (days), and Z is the
due date (days).

Advantages of Trade Credit: Trade credit

has several advantages:

There are two types of trade credit:

i) Open account
ii) Trade note payable

1. Availability: Except for firms in

financial trouble, trade credit is almost
automatic, and no negotiations or special
arrangements are required to obtain it.
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2. Flexibility: If the firms sales increase,

causing its purchases of goods and services
to increase, trade credit will grow
automatically. Likewise, if the firms sales
decrease, causing purchasing needs to drop,
trade credit will likewise decrease.

3. Few or No Restrictions: Trade credit

terms are much less restrictive than those
of negotiated sources of funds.

% Cash discount
Visible cost of forgoing cash discount=---------------------------------------X
100% - % cash discount

365

/N

Visible cost of penalty charges= (percentage penalty per year) X (number of periods per year)
Costs of Trade Credit:
Prompt Payment

Delayed Payment
1.Cost of forgoing cash discount
2. Penalty charge for late payment

None
Costs passed on to Buyer by Seller for:

1. Carrying Costs
2. Credit checking
3. Bad-Debt losses

Cost of paying late

Accruals: Accruals means continually

recurring liabilities representing services
received for which payment has not been
made.

Single Loan: This type of loan is

appropriate when the firm needs shortterm funds for only one specific purpose.
Lines of Credit: Line of credit refers to
an informal, multi-credit arrangement
between a bank and its customer. It
specifies the maximum amount of the
unsecured credit the bank will permit the
firm to owe at any one time. This may
include a Cleanup provision under
which the borrower is required to owe
the bank nothing for a time during the
year.

Accrued Expenses: Amounts owned but

not yet paid for wages, taxes, interest,
and dividends. The accrued expenses
account is a short-term liability.
Negotiated Short-Term Financing:
Short-Term Bank Loan: A short-term
bank loan is a business loan from a
commercial bank that will be repaid
within one year.
Types of Short-Term Bank Loan:

Revolving
Credit
Agreement:
A
revolving credit agreement is a formal
agreement; the bank is legally committed
to provide credit, up to some maximum

1. Single loan
2. Lines of credit
3. Revolving credit
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limit established, on demand by the firm.

The firm pays a commitment fee, usually
between 0.125% and 0.5% per year (It
will pays on the unused portion of the
loan).

Factoring Receivables: The firm can

acquire short-term financing is to sell its
accounts receivable to a company that
specializes in buying this kind of assets.
These companies are called factors, and
this procedure is called factoring.

Open Market Loans:

Commercial Paper: Commercial paper is
a form of unsecured promissory note,
with maturity from 3 to 270 days that
firms issue to raise short-term funds. The
commercial paper market is a blue-chip
market; only the financially strongest and
sound firms can issue commercial paper.

The firm may use factoring in two ways:

(1) as a continuous process or (2) on an
ad hoc basis. Typically, factoring is a
continuous process.
There are two cost components involved
in factoring: (1) the commission and (2)
the interest on any advance paid to the
firm.

Face valueSale price

365
Interest Yield=-----------------------------x--------------------Sale price
Days to maturity

There are two principal disadvantages:

Bankers Acceptance: The short-term

promissory notes for which a bank (by
having accepted them) promises to pay
the holder the face amount at maturity.

First is the administrative burden of the

constant shuffle of information between
factor and firm. Second, there has been a
long-standing reluctance to use factoring
because it has been perceived as a sign of
financial weakness.

Secured Loans: A form of debt for

money borrowed in which specific assets
have been pledged to guarantee payment.

Pledging
Receivables:
Pledging
receivables refers to using accounts
receivable as collateral for a loan, but
unlike factoring, the legal ownership of
the receivables remains with the firm.

Lending Agent: Finance companies are

specialized lending agents.
Factor: Firm that purchases accounts
receivable at a discount and is
responsible for processing and collecting
on the balances of these accounts;
finance companies commonly have
subsidiaries that serve as factors.

Inventory Loan: Inventory is another common

source of loan collateral. Because it is fairly
liquid, which is one of the primary conditions
for short-term collateral; banks and finance
companies willingly accept most standard types
of inventories as collateral.

Factors perform three functions for the

firm:
1. Credit checking
2. Financing, and
3. Risk bearing

Lien: The legal right to keep somebody

elses property as security for a debt.
Blanket Lien: A blanket lien is an allinclusive lien that gives the lender
recourse to all the firms inventories.
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warehouse on the firms property. The

warehousing company physically sets off
the pledged inventory in an area that can
be controlled (this may be done with a
fence or by using a temporary building),
and the warehousing agent polices this
inventory, releasing any or all of it only
on directions from the lender.

Terminal Warehouse: A terminal

warehouse is a public warehouse, where,
for a fee, goods are stored. Under a
terminal warehouse receipt loan,
inventory may be removed from storage
only on approval of the lender, providing
the lender good control over the loan
collateral.

Trust Receipt: A trust receipt is a pledge

by the firm that it will keep the identified
inventory as collateral for the lender until
its sale, at which time the proceeds of the
loan will be returned to the lender.
Field Warehouse: A field warehouse is
an arrangement that establishes a
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