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Chapter 16
Short-Term Business FinancingShort-Term Business Financing
© 2003 John Wiley and Sons
2
Chapter Outcomes Identify and describe strategies for
financing working capital. Identify and briefly explain the factors that
affect short-term financing requirements. Identify the types of unsecured loans
made by commercial banks to business borrowers.
Describe the use of accounts receivable, inventory, and other sources of security for bank loans.
3
Explain the characteristics, terms, and costs of trade credit.
Explain the role of commercial finance companies, factors, Small Business Administration, and commercial paper in providing short-term business financing.
Chapter Outcomes, continued
4
Strategies for Financing Working Capital
Working capital Net working capital NWC and financing strategy
– If NWC>0
$ of current assets financed with long-term funds
– If NWC<0
$ of fixed assets financed with current liabilities
5
Another way to look at a firm’s assets...
Fixed Assets Permanent current assets Temporary current assets Asset levels fluctuate over time for a
firm
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Asset Trends for a Growing FirmA
sset
s ($
)
Time
Fixed Assets
Permanent Current Assets
Temporary or Fluctuating Temporary or Fluctuating Current AssetsCurrent Assets
7
Asset Trends for a Growing Firm:Maturity Matching
Ass
ets
($)
Time
Fixed Assets
Permanent Current Assets
Temporary or Fluctuating Temporary or Fluctuating Current AssetsCurrent Assets
Lon
g-te
rm f
inan
cin
gSh
ort-
term
fi
nan
cin
g
8
Asset Trends for a Growing Firm:Aggressive Financing
Ass
ets
($)
Time
Fixed Assets
Permanent Current Assets
Temporary or Fluctuating Temporary or Fluctuating Current AssetsCurrent Assets
Lon
g-te
rm f
inan
cin
gSh
ort-
term
fin
anci
ng
9
Asset Trends for a Growing Firm:Conservative Financing
Ass
ets
($)
Time
Fixed Assets
Permanent Current Assets
Temporary or Fluctuating Temporary or Fluctuating Current AssetsCurrent Assets
Lon
g-te
rm f
inan
cin
gSh
ort-
term
fin
anci
ng
10
Basic Financing Strategies
Maturity matching
Aggressive
Conservative
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Financing Strategy Problems
Over-reliance on short-term debt
– Exposure to increases in short-term rates
– Difficulties in rolling over debt
– Forced to acquire long-term financing at inopportune times
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Problems Not Caused by Financing Strategy
Dot coms
– Market ignored cash flow generation—or lack thereof!
Ethical lapses
13
Influences on the short-term/long-term financing decision
Industry and Company Factors– Ratios of short-term financing to assets
AT&T 15.4%Consolidated Edison 13.3ExxonMobil 25.6General Motors 20.5Microsoft 18.7Sears 42.8Walgreens 34.1Walmart 37.1
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Influences on the short-term/long-term financing decision
Current assets/total assets relationship
Growth Seasonal variation Firm life cycle/sales trends
15
Patterns of Short-Term and Long-Term Financing over Time
Pattern of Short-Term Financing
Pattern of Long-Term Financing
Time
Time
$
0
$
0
16
Influences on the short-term/long-term financing decision
Cyclical variation Other influences
– Flexibility– Relationship with short-term
lenders– Concern over constant debt
rollover, exposure to interest rate spikes
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Commercial Bank Lending
Line of Credit
Revolving Credit Agreement
Accounts Receivable Financing
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Line of Credit
Clean up period Periodic re-approval Compensating balance versus fees
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Computing interest rates
EAR = (1 + APR/m)m - 1 $10,000 loan, 6 months, 8%APR EAR = (1 + .08/2)2 - 1 = 8.16%
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Discounted Loans
Discounted loan $ received = loan amount - interest = $10,000 - $400 = $9600
Periodic rate = $400/9600
APR = 8.51% Loan request = funds needed
1 - discount %
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Revolving Credit Agreement
Commitment by bank Charge on unused funds
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Accounts Receivable Financing
Pledging receivables– <80 percent of AR value
Interest rate + fees
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Inventory Loans
Percent of value lent depends on inventory characteristics
Blanket inventory loan Trust receipt Warehouse receipt
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Technology in Short-term Financing
Digital writing/recording devices (e.g., digital cameras)
B2B auction sites for surplus goods
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Loans can be secured by...
Stock and bonds Cash value of life insurance policy Co-signer Acceptances
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Trade Credit
Net date Trade discounts
2/10 net 30 Cost of trade credit
Pay $98 within 10 days or pay $100 within 30 days
Cost: extra $2 for delaying 20 days
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Cost of Trade Credit
Cost: extra $2 on a $98 charge for delaying 20 days
Approx. effective cost = 2/98 x 365/20 = 37.2%
General formula:
Percent discount x 3 6 5 days
100%-discount % net days-discount days
28
Commercial Finance Companies
Organization without a bank charter that advances funds to businesses
– discounts receivables
– secured machinery loans
– inventory loans
– leases Higher cost than bank loans
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Factors
Purchases receivables and assumes credit risk
Can supplement or replace a firm’s credit department
Two types of factoring:– maturity factoring– advance factoring
Cost: interest plus charges
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Other sources
Small business:– SBA guaranteed loans
Large business:– commercial paper– Sold via broker, dealer, electronic
trading system– proceeds =
issue size less interest less
placement fees