Short Term financing
The seasonal financial needs of a company may be
covered by short-term sources of funds. Businesses spend these funds on
salaries and for emergencies. The outside sources of short-term funds are
divided into secured and unsecured ones. Unsecured financing is financing that is not
backed by collateral. A company seeking unsecured short-term capital has
several options: they include trade credit, promissory notes, hank loans, commercial
papers and commercial drafts.
About 85 % of all US business transactions involve
some form of trade
credit. When
a business orders goods and services, it doesn't normally pay for them. The
supplier provides them with an invoice requesting payment within a settled time
period, say thirty days. The usual repayment period is 30 to 90 days. During
this time the buyer uses goods and services without paying for them.
A company can use the trade
credit as a source of savings. A typical trade arrangement is 2/10, net 30. If
a buyer pays within 10 days instead of 30, he gets a 2 % cash discount. The
savings a buyer obtains can be used as a source of short-term funds.
A promissory note is a written pledge by a borrower to pay a certain sum
of money to a creditor at specified future date. Suppliers that are uneasy
about extending trade credit may be more willing to offer credit to customers
that sign promissory notes. Unlike trade credit, however, promissory notes
usually provide that the borrower pay interest.
Commercial banks lend money to their customers by direct unsecured loans. Only customers with an
excellent credit rating can get these loans. They usually repay them within a
year's time. Banks also lend money by setting up lines of credit. The line of credit is a prearranged short-term
loan. It is the amount a customer can borrow without making a new request,
simply by notifying the bank. A bank that offers a line of credit may require
that a compensating balance be kept on deposit at the bank. This balance may be
as much as 20% of the line-of-credit amount. The bank may also require that
every commercial borrower pay off completely its line of credit at least once
each year and not use it again for a period of 30 to 60 days. This second
requirement ensures that the line of credit is used only to meet short-term
needs and that it doesn't gradually become a source of long-term financing.
Commercial paper is short-term promissory notes
issued by large corporations. Commercial paper is secured only by the
reputation of the issuing firm; no collateral is involved. It is usually issued
in large denominations, ranging from $5,000 to $100,000. Corporations issuing
commercial paper pay interest rates slightly below those charged by commercial
banks. Thus, issuing commercial paper is cheaper than getting short-term
financing from a bank.
A commercial draft is a written order requiring a
customer (the drawee) to pay a specified sum of
money to a supplier
(the
drawer) for
goods or services. It is often used when the supplier is unsure about the
customer's credit standing. The draft would be completed as follows:
1.
The draft form is filled out by the drawer. The draft
contains the purchase price, interest rate, if any, and maturity date.
2.
The draft is sent by the drawer to the drawee.
3.
If the information contained in the draft is correct
and the merchandise has been received, the drawee marks the draft
"Accepted" and signs it.
4. The
customer returns the draft to the drawer. Now the drawer may:
•
hold the draft until maturity;
•
discount the draft at its bank;
•
use the draft as collateral for a loan. If a business
cannot obtain enough capital via unsecured short-term financing, it must
put up collateral to obtain
the additional financing it needs. Almost any asset can serve as collateral.
However, inventories
and accounts receivable are the assets that are most
commonly used for short-term financing.
Loans Secured by Inventory Normally, marketing
intermediaries and producers have large amounts of money invested in finished
goods or merchandise inventories. In addition, producers carry raw materials
and work-in-process inventories. All three types of inventory may be pledged as
collateral for short-term loans. However, lenders prefer the much more salable
finished goods to the other inventories.
A special type of secured financing called floor planning is used by automobile,
furniture, and appliance dealers. Floor planning is a method of financing where the title to
merchandise is given to lenders in return for short-term financing. The major
difference ;>between floor planning and other types of secured
short-term financing is that the borrower maintains control of the inventory.
As merchandise is sold, the borrower repays the lender a portion of the loan.
To ensure that the lender is repaid a portion of the loan when the merchandise
is .sold, the lender will occasionally check to ensure that the collateral is
still in the borrower's possession.
Loans Secured by Receivables Accounts receivable are
amounts that are owed to a firm by its customers. They arise primarily from
trade credit and are usually due in less than sixty days. It is possible for a
firm to pledge its accounts receivable as collateral to obtain short-term financing.
A lender may advance 70 to 80
% of the dollar amount of the receivables.
Sometimes a company might sell its accounts receivable
to a special financial broker: a factoring company or a factor. The factor immediately pays
the firm cash, usually 50 to 80
% of the value of the accounts receivable. When
customers make the payments on the firm's accounts, the money goes directly to
the factor. The factor's profit is thus the difference between the face value
of the accounts receivable and what the factor has paid for them. Even though
the selling firm gets less than face value for its accounts receivable, it does
receive needed cash immediately. Moreover, it has shifted both the task of
collecting and the risk of nonpayment to the factor, which now owns the
receivables.
