Chapter 8

Sources of Short-TermFinancing

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PPT 8-1FIGURE 8-1The prime rate versus the London InterbankOffered Rate on U.S. dollar deposits

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PPT 8-2FIGURE 8-2Total commercial paper outstanding

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PPT 8-3TABLE 8-1Comparison ofcommercial paperrate to primerate (annual rate)*

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Chapter 8 - Outline LT 8-1

Sources of Short-Term Financing Trade Credit Net Credit Position Bank Credit Terminology Types of Bank Loans Corporate and Foreign Borrowing Terminology Accounts Receivable Financing

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Sources of Short-Term Financing LT 8-2

There are various sources of short-term funds available to a firm:– Trade Credit from Suppliers– Bank Loans– Corporate Promissory Notes– Foreign Borrowing– Loans Against Receivables and Inventory

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Trade Credit LT 8-3

The largest source of short-term financing for a firm

It is usually a 30-60 day grace period before a bill is due

A cash discount is often given if payment is made within a specified time– Ex., 2/10 net 30 means a 2% discount is given if

paid in 10 days; if not, the full amount is due in 30 days

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Net Credit Position LT 8-4

Net Credit Position:– a firm’s Accounts Receivable (A/R) minus its

Accounts Payable (A/P)– if A/R is greater than A/P, it is a net provider of

trade credit (positive number)– if A/P is greater than A/R, it is a net user of trade

credit (negative number)– larger firms tend to be net providers of trade credit,

while smaller firms are net users

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Bank Credit Terminology LT 8-5

Prime Rate:– the interest rate charged to a bank’s best customers– acts as a benchmark for calculating other interest rates

Compensating Balance:– when a bank requires a minimum average account balance

for business customers in order to qualify for a loan– can be thought of as a form of collateral

Effective Interest Rate:– the actual interest rate or “true” cost of a loan– also known as the annual percentage rate (APR)

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Types of Bank Loans LT 8-6

Discounted Loan:– when a bank deducts the interest on the loan in advance and

lends the balance

Installment Loan:– calls for a series of equal payments over the life of the loan– ex., most car loans and home mortgages

Compensating Balance Loan:– when a compensating balance is required as part of the loan

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Corporate and Foreign Borrowing Terminology LT 8-7

Commercial Paper:– a short-term unsecured promissory note issued to the public in

minimum units of $25,000– total amount of commercial paper outstanding has increased

greatly in recent years

Eurodollar:– a U.S. dollar held or deposited in a foreign bank– loans from foreign banks denominated in American dollars are

called Eurodollar loans

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Accounts Receivable Financing LT 8-8

A/R financing includes 2 choices:– pledging accounts receivable as collateral for a loan OR– an outright sale (also called factoring) of

receivables to a bank or finance company Tends to be a relatively expensive source of

financing