F9 Lecture

8/13/2019 F9 Lecture

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Gitman,Juchau& Flanagan:Principles of Managerial Finance 4e 2005 Pearson Education Australia

Chapter 15

Current liabilities management

COMM2001 Financial Management

Tony Stanger

Gitman,Juchau& Flanagan:Principles of Managerial Finance 4e 2005 Pearson Education Australia2

Learning Objectives

discuss the firms credit terms

see the effect of st retching accounts payable

describe unsecured types of short term credit

describe secured types of short term credit

explain how to use inventory as collateral


Spontaneous liabilities

Spontaneous liabilities are types of funding t hat arise from the

normal operations of the firm

two main types - accounts payable

- accruals

advantages

- unsecured short term financing (no pledging of specific

assets as collateral involved)

- interest-free financing (no borrowing involved)


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Accoun ts payabl e management invo lves maximisin gthe time between purchase of suppli es and

mailing payment to the supplier (withoutdamaging credit rating)

eg. if the terms are net 30, the accoun t should b epaid 30 days from the beginning of the creditperiod

result: stretching accounts payable allowsmaximum use of interest-free loan



Analysing c redi t terms invol ves choosin g whether to

pay invoices early or late

eg. if the firm is offered credit terms for N daysthat include a cash discount (CD), it has twooptions: to take the cash discount or forgo it

result depends on cost of forgoing cash discount

= CD/(100%-CD) x 365/N



Accruals are liab il it ies f or serv ices recei ved forwhich payment has yet to be made

examples: wages, taxes

eg. delay payment of wages

delay payment of taxes

result: interest fr ee loan from workers,

government


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Unsecured sources of short term loans

Unsecured types of fi nancing involve no col lateral

being pledged by the borrower

bank loans are a common form

- typically in the form of an overdraft

- can be used by small firms and big firms

- provides funding for seasonal peaks



Bank loan interest rates

prime rate = lowest rate charged by banks to their best

customers

fixed rate loan = loan with constant rate until maturity (set at

a fixed margin above the p rime rate)

floating rate loan = loan w ith variable rate (set at a flexible

margin above the pri me rate)



Bank loan interest rate calculation

nominal rate of interest

- equals the contract rate

- reflects the borrowers credit standing

effective rate = (interest) / (amount b orrowed) if i nterest is

paid at maturity

discount loan rate

= (interest) / (amount borr owed - interest)


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Bank loan terminology

overdraft

- a short term self liquidating loan subject to a

pre-determined li mit

- operates by allowing the borrowers cheque

account to go into deficit

- may involve an interest charge on the unused

portion of the overdraft



Bank loan terminology

operating change restrictions are contractual regulationsthe bank imposes on the borrower

eg - regular financial statements

- notification of major business changes

compensating balances is an amount t he bank may requirethe firm to maintain in its cheque account

annual clean-ups require the b orrower to keep a zerooverdraft balance for N days per year



Bill and note finance

a bill of exchange is a written, unconditional

order involving t hree parties for a specified sum

to be paid on a specified date

the draweris the issuing party (= borrower) the acceptoragrees to pay ( = bank) the endorserpurchases the bill (= lender)


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bank-accepted bills of exchange are bills th athave been accepted by a bank

implications:the bank gaurantees the credit risk

the bill trades as a low-risk security the bill trades at a low yield the bill is highly liquid







commercial bills of exchange are bills notaccepted or endorsed by a bank

promissor y notes are short term unsecuredcommercial loan instruments

note: CBs need to be endorsed when transferred

PNs are transferable without endorsement


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Bill and note fin ance interest calculation

interest is determined by the size of the discoun t(D) and length t o maturit y (N days)

Example: Bertram Ltd issues $1m worth of P-noteswith 90-day matur ity at p rice (P) of $98,000

Solution : the 90-day interest rate is 2.04% (=$20,000/$980,000) and the effective annualinterest rate is 8.41% = [(1+0.0204)4 -1]



International loans are frequently associated withinternational trade transactions

a common form is a letter of credit = a letterwritt en by a companys bank to a foreign supplierof goods st ating that the bank guaranteespayment of a foreign currency i nvoice amount

netting : of fshore transactions betweensubsidiaries creates the opportunit y to minimiseFX transactions cost s


Secured sources of short term loans

Secured types of fi nancing involve collateral beingpledged by the borrower

a security agreement specifies the coll ateral held

against the loan, including:- nature of asset

- conditions of release

- rights of claim

agreements are registered with ASIC


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Ordinary collateral

lenders try to match collateral duration toloan length

a percentage advance is a % of the assets bookvalue that constitutes the principal

a service charge will be payable for t he lendersadministration expenses



Accoun ts r eceiv able as co ll ateral

a pledge of accounts receivable involves usingthe firms accounts as security to obtain a loan

the pledging process involves scrutiny by thelender of the quality and value of the accounts

pledges can be on a notification or non-notification basis,depending on whether the account customer is informed

their account is being u sed as collateral



Factoring accounts receivable

involves the outri ght sale of accounts receivableat a discount to a bank (called the factor) in

exchange for credit

Invoice discounting

is the sale of accounts receivable to adiscounter, where the accounting fun ction is

retained by the firm


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Factoring and invoi cing discounti ng agreements

a lender selects accounts for purchase based onacceptable credit ris k

usually on a non-recourse basis, which is anunderstanding that the factor accepts all credit

risks



Using inventory as short term collateral

seen as second to accounts receivable ascollateral

advantage: in ventory has greater market valuethan its book value

a floating charge over inventory is a lendersclaim on the borrowers inventory


Tutorial Week 13

Review Questions

15-1, 15-2, 15-3, 15-5 & 15-2

Problems 15-3, 15-7, 15-12* & 15-16 *

* The solution to th ese problems will be available onWebCT.

Documents

F9 Lecture