Presented by: Jana Aming Edsel Tiu John Carlos Wee

FLOW OF PRESENTATION

INTRODUCTION FINANCING STRATEGIES SHORT-TERM CREDIT ADVANTAGES AND DISADVANTAGES OF SHORT-TERM FINANCING SOURCES OF SHORT-TERM FINANCING FACTORS IN SELECTING SOURCE OF SHORT-TERM FUNDS

FLOW OF PRESENTATION
UNSECURED

SOURCES OF SHORTTERM CREDIT

SPONTANEOUS SOURCES TRADE CREDIT ACCRUALS NEGOTIATED SOURCES
BANK LOANS SINGLE PAYMENT NOTE LINE OF CREDIT REVOLVING CREDIT AGREEMENT COMMERCIAL PAPER

FLOW OF PRESENTATION
SECURED

SOURCES OF SHORT-TERM

LOANS
ACCOUNTS RECEIVABLE FINANCING PLEDGING/ASSIGNMENT FACTORING INVENTORY FINANCING
BLANKET (FLOATING) INVENTORY LIEN TRUST RECEIPTS LOAN AND CHATTEL

MORTGAGE WAREHOUSING RECEIPT LOANS

INTRODUCTION

One of the most important decisions that must be made with respect to working capital management is how short-term credits will be used to finance working capital.

FINANCING STRATEGIES
Financing

strategies of the company usually depends on the financing needs of the company.

Categories of Financing Needs of the Company:

1. Permanent Need 2. Seasonal Need

FINANCING STRATEGIES
Alternative Short-Term Financing Strategies/Policies
1. Aggressive Financing Strategy/Policy 2. Conservative Financing Strategy/Policy 3. Hedging (Self-Liquidating) Financing

Strategy/Policy

SHORT-TERM CREDIT
Also

called short-term/current liability, this is any debt scheduled to mature within one year or one operating period.

ADVANTAGES AND DISADVANTAGES OF SHORTTERM FINANCING

Advantages 1. Speed 2. Flexibility 3. Cost Associated to Short-Term Financing vs. Long-Term Financing Disadvantage 1. Risks Associated to Short-Term Financing vs. Long-Term Financing

SOURCES OF SHORT-TERM FINANCING

Unsecured

Credit Sources

Spontaneous Liabilities Trade Credit Accruals Negotiated Sources

Bank Loans Commercial Papers

Secured

Credit Sources

Accounts Receivable Financing Inventory Loans

FACTORS IN SELECTING SOURCE OF SHORT-TERM FUNDS

1. 2. 3.

4.

The effective cost of credit. The availability of credit. The influence of the use of a particular credit source on the cost and availability of other sources of financing. Any additional covenants or restrictions.

Current Liabilities Management

UNSECURED SOURCES OF SHORT-TERM CREDIT

These

include all those sources that have their security only the lenders faith in the ability of the borrower to repay the funds when due. They are obtained without pledging specific assets as collateral. Unsecured sources fall in two major categories:
1. Spontaneous Sources, and 2. Negotiated Sources.

SPONTANEOUS SOURCES
These

are short-term credits arising from the normal course of business. There are no interest costs attached to these sources. However, they may have some implicit costs. Two major sources:
1. Accounts Payable 2. Accruals

TRADE CREDIT (ACCOUNTS PAYABLE)

This

is a debt arising from credit purchases by a firm without issuing any formal note as an evidence of the firms liability to its supplier(s). It is considered as a primary source of spontaneous financing because it arises from ordinary business transaction.

TRADE CREDIT TERMS

Cash

on Delivery (COD) and Cash Before Delivery (CBD) Net Period

Without Discount With Discount

Dating

TRADE CREDIT FINANCING

Availing

trade credits, technically, is not discretionary financing strategy. The discretionary portion of trade credit financing lies on the period when the company pays its accounts payable. Payment decisions:
1. Taking the cash discount. 2. Payment at the last day of credit terms. 3. Stretching accounts payable.

COST OF CREDIT TRADE FINANCING

Without Cash Discount: IMPLICIT COST: The difference between the selling prices through cash purchase and credit purchase. (If credit purchases are stated higher than cash purchase) EXPLICIT COST: NONE

COST OF CREDIT TRADE FINANCING

With Cash Discount: IMPLICIT COST: Annualized Cost of Foregone Discount
Approx. Effective Annual Cost of Foregoing Cash Discount = Discount Rate 100% - Disc. Rate X No. of Days in A Year Credit Period - Disc. Period

EXPLICIT

COST: NONE

ADVANTAGES OF TRADE CREDIT

Availability

readily available; no need for negotiation, unless required by the supplier. Flexibility payment can be made anytime within the credit period and may be stretched depending on the negotiation with the supplier.

ACCRUALS (ACCRUED EXPENSES)

These

are company liabilities for services that have been provided for the company but are not yet paid. sources of accruals:

Common

Labor (Salaries and Wages) Taxes Interest

ACCRUAL ACCOUNTS FINANCING

Like

trade credits, availing of accruals as financing source is technically nondiscretionary in nature. Also, only accruals controllable by the company may have discretionary characteristics in this source of financing.
Taxes are controlled by the government

(due dates are set, usually 10-15 days after close of each month.

ACCRUAL ACCOUNTS FINANCING

The

most common source of accrual accounts financing is the unpaid salaries of employees. The company may have the discretion on the period of payment for the employees salary (e.g. monthly at the end of each month, monthly at ten days after close of each month, every half a month, etc.).

COST OF ACCRUAL FINANCING

IMPLICIT

COST: NONE EXPLICIT COST: NONE

NEGOTIATED SOURCES
These

are short-term credits arising from the negotiation entered into by the borrowing firm and the potential creditors, usually banks and other corporations, evidenced by a formal note or some other documents.

Two major sources:

1. Bank Loans 2. Commercial Papers

COMMERCIAL BANK LOANS

These

are short-term business credit provided by commercial banks, requiring the borrower to sign a promissory note to acknowledge the amount of debt. of Short-Term, Unsecured Bank

Types

Loans:
1. Single-Payment Notes 2. Lines of Credit 3. Revolving Credit Agreements

SINGLE-PAYMENT NOTE
This

is a short-term, one-time loan made to a borrower who needs funds for a specific purpose for a short period. instrument: A Note stating the terms of the loan, including the maturity period of the loan and the interest rate, usually stated on a per annum basis.

Resulting

LINE OF CREDIT
This

is an informal agreement between a bank and a borrower-company specifying the maximum amount of unsecured short-term borrowing the bank will make available to the firm over a period of time, usually one (1) year and subject to one (1) year renewals.

LINE OF CREDIT
Some

Restrictions/Conditions:

Operating-Change Restrictions contractual

restrictions that a bank may impose on a firms financial condition or operations as part of the agreement Compensating Balances a required account balance equal to a certain percentage of the amount borrowed from the bank under the same agreement.

LINE OF CREDIT
Some

Restrictions/Conditions:

Annual Cleanup the requirement that for a

certain number of days or months during the year, borrowers under a line of credit carry a zero-loan balance.
Interest

Rate on this type of agreement is usually stated as a floating rate the prime rate plus a premium.

REVOLVING CREDIT AGREEMENT

This

is a formal, legal commitment by the bank to extend credit up to a stated maximum amount for a given period of time. to the features of this type of loan, the bank usually charges commitment fee on an amount unused by the borrower.

Due

COST OF BANK LOANS

EXPLICIT

COST: Effective Interest on the Loan, plus add-ons (Premium, Compensating Balances, etc.)

COMPUTING EFFECTIVE INTEREST RATES

Without Compensating Balance: Simple Interest:
Interest Rate SIMPLE = Interest Face Value of the Loan

Discount

Interest:
= Interest Face Value - Interest

Interest Rate DISCOUNT

COMPUTING EFFECTIVE INTEREST RATES

With Compensating Balance: Simple Interest:
Interest Rate SIMPLE = Nominal Rate 1.0 - Compensating Balance (%)

OR
Interest Rate SIMPLE = Interest Face Value - Compensating Balance

COMPUTING EFFECTIVE INTEREST RATES

With Compensating Balance: Discount Interest:
Interest RateDISCOUNT = Interest Face Value - Interest - Compansating Balance

OR
Interest Rate DISCOUNT = Nominal Rate 1.0 - Nominal Rate - Compensating Balance (%)

COMMERCIAL PAPER

This is an unsecured short-term promissory note issued by large, strong credit rating companies to other companies and institutions, such as trust funds, banks and insurance companies. papers can be obtained through the money market (a type of financial market for trading of short-term securities).

Commercial

ADVANTAGES AND DISADVANTAGES OF COMMERCIAL PAPERS

ADVANTAGES: Less costly than trade credit and bank loans. Not subject to possible restrictive covenants contained in most bank loans.

ADVANTAGES AND DISADVANTAGES OF COMMERCIAL PAPERS

DISADVANTAGES: Commercial papers have fixed maturity rate, exposing it to liquidity risk (the risk of non-conversion of the security into cash at maturity). Commercial papers have limited access and user availability.

COST OF COMMERCIAL PAPER

EXPLICIT

COST: Effective Interest Cost plus Issue Cost

Computation:
Effective Rate DISCOUNT = Interest + Issue Costs Face Value - Interest - Issue Costs X No. of Days in a Year Days to Maturity of the Paper

Current Liabilities Management

SECURED SOURCES OF SHORT-TERM LOANS

These

are short-term loans that use some specific assets as collateral in securing the loan. typically used as collateral in secured short-term credits:

Assets

1. Accounts Receivable, and 2. Inventory (Merchandise/Finished Goods).

ACCOUNTS RECEIVABLE FINANCING

Accounts

Receivables (Trade Receivables) are financial assets of a company arising from the sale of companys goods and services to customers. They represent a contractual right of the company to receive cash from the customer. The use of accounts receivable in obtaining loans are considered to be common to most enterprises because of its being attractive to most lenders due to its liquidity.

ACCOUNTS RECEIVABLE FINANCING

Two

means of using accounts receivable in obtaining short term financing:

1. Pledging or Assignment of Accounts

Receivable 2. Factoring of Accounts Receivable

PLEDGING OR ASSIGNMENT OF ACCOUNTS RECEIVABLES

In

this form of accounts receivable financing, certain amount of accounts receivable are pledged or assigned as a collateral to a loan. The Pledging Process:
1. Selection and evaluation of accounts

receivables used as collateral; 2. Adjustment of receivable value for allowances, usually on a fixed percentage; 3. Determination of loan amount.

PLEDGING OR ASSIGNMENT OF ACCOUNTS RECEIVABLES

Pledging

can be made on a notification or non-notification basis.

In a non-notification basis, the borrower

continues to collect from the customers the amount of the receivable and remits the same to the lender. In a notification basis, the borrower notifies the customers to remit their payment directly to the lender.

ADVANTAGE AND DISADVANTAGE OF PLEDGING/ASSIGNMENT

Advantage:
Flexibility in the use of accounts receivable

as collateral
Disadvantage
Relative higher cost compared with other

short-term financing sources.

COST OF PLEDGING ACCOUNTS RECEIVABLE

EXPLICIT

COST: Effective Cost

Computation:
Effective Cost = Interest + Processing Charge Face Value of the Loan

FACTORING OF ACCOUNTS RECEIVABLES

This

form of accounts receivable financing involves the outright sale of accounts receivable, usually at a discount, to a finance company known as a factor. The Factoring Process:
1. Selection and evaluation of accounts

receivables used as collateral; 2. Determination of loan amount, considering retention of certain amount for any allowances and returns.

FACTORING OF ACCOUNTS RECEIVABLES

Factoring

of accounts receivable are usually done on a notification basis and are oftentimes made on a nonrecourse, thus substantial transfer of risks and returns of ownership to the receivable is made.

COST OF FACTORING ACCOUNTS RECEIVABLE

EXPLICIT

COST: Effective Cost

Computation:
Effective Cost Interest + Factor Fee/Commission Number of days in a year = Face Value of the Loan - Factor Fee/Commission X Credit Terms - Interest - Reserves/Retention Money

INVENTORY FINANCING
Inventories

are goods or items which are held for sale in the ordinary course of business, or those which are in the process of production for such sale, or those materials or supplies that are to be consumed in the production process or in the rendering of services. They also encompass those goods purchased and are held for resale by the company.

INVENTORY FINANCING
Because

of the marketability of inventories and their market value being usually higher than the book value, inventories are also desirable forms of collateral for loans. However, not all types of inventories may be used as collateral. The best inventory items to be pledged as collateral for loans are those that are highly marketable and generic in nature.

INVENTORY FINANCING
Forms

of Inventory Financing:

Blanket (Floating) Inventory Lien Trust Receipt Agreements/ Chattel

Mortgage Warehouse Receipt Loans

BLANKET/FLOATING INVENTORY LIEN

Under

this form of inventory loan, the lender has a general claim over the inventory items held by the borrower, thus no specific item is assigned to the loan. The borrower, in this type of inventory loan, retains full control over the inventory.

TRUST RECEIPTS LOAN AND CHATTEL MORTGAGE

Under

the trust receipt loan and chattel mortgage, certain inventory items are specifically identified and are used as collateral for loan. Oftentimes, these inventory items are identified via serial numbers. The items used as collateral are still being held by the borrower.

TRUST RECEIPTS LOAN AND CHATTEL MORTGAGE

In

the chattel mortgage, the sale of the inventory items may not be done unless consented by the lender. In the trust receipts loan, a trust receipt is generated and is being used in selling of the items. Thus, there is general permission on the sale of the inventory items by the borrower in trust of the lender, the proceeds from the sale of which should be remitted by the former to the latter.

WAREHOUSE RECEIPT LOAN

This

is an arrangement whereby the lender receives full physical and legal control of the identified inventory collateral, which is stored under the care of a warehousing company serving as an agent of the lender. Two types of warehousing agreement:
Terminal Warehouse Receipt Loan Field Warehouse Receipt Loan

COST OF INVENTORY FINANCING

EXPLICIT

COST: Effective Cost

Computation:
Effective Cost = Interest + Warehousing Fee Net Proceeds of Loan X Number of days in a year Term of Loan

REFERENCES:
BOOKS: Cabrera, Ma. Elenita, FINANCIAL MAANGEMENT, PART I, 2012 Edition, Conanan Educational Supply, Manila E-BOOKS: Gitman, Lawrence J., PRINCIPLES OF MANAGERIAL FINANCE, 10th Edition Brigham, Eugene F. and Houston, Joel F., FUNDAMENTALS OF FINANCIAL MANAGEMENT, 10th Edition Van Horne, James C., FINANCIAL MANAGEMENT AND POLICY, 12th Edition