1 © Copyright Doug Hillman 1999 Short-Term Financing

2 © Copyright Doug Hillman 1999 Financing Considerations l Interest cost l Continuing availability of financing method l Effects on availability and cost of alternative sources of money

3 © Copyright Doug Hillman 1999 Promissory Note l Unconditional written promise to pay

4 © Copyright Doug Hillman 1999 Promissory Note l Unconditional written promise to pay a definite sum of money

5 © Copyright Doug Hillman 1999 Promissory Note l Unconditional written promise to pay a definite sum of money on demand or at a future date.

6 © Copyright Doug Hillman 1999 Promissory Note l Unconditional written promise to pay a definite sum of money on demand or at a future date. l Person promising to payee is maker l Person promised the payment is payee

7 © Copyright Doug Hillman 1999 Characteristics of Promissory Note l In writing and signed by maker l Unconditional promise to pay a certain sum of money l Payable to a bearer or stated person l Payable on demand or a specified future time l May or may not be interest bearing

8 © Copyright Doug Hillman 1999 Maturity Date l Date when payment is due l Calculation ›Days in month note is dated minus date of note ›Add number of days in succeeding months until total is reached

9 © Copyright Doug Hillman 1999 Computing Interest l Interest= Principalx Rate x Time l Maturity stated in days l $30=$1,000x0.12x90/360 l Maturity stated in months l $50=$1,000x0.12x5/12 l Maturity stated in years l $240=$1,000x0.12x2

10 © Copyright Doug Hillman 1999 Maturity Value of Note l Principal amount plus interest to maturity l $1,000, 12%, 90 day note l $1,000 + $30 = $1,030

11 © Copyright Doug Hillman 1999 Annual Effective Interest Rate l Average annual interest cost l divided by l Average outstanding principal l Borrow $1,000 with 24 payments of $50 l 24 x $50 = $1,200 l $1,200 - $1,000 = $200 l $100 / $500 = 20%

12 © Copyright Doug Hillman 1999 Issuance of Note Bearing Interest on Face Value l At issuance ›Increase Cash for amount received (face value) ›Increase Notes Payable for face value l At maturity ›Decrease Notes Payable for face value ›Increase Interest Expense for interest to maturity ›Decrease Cash for total

13 © Copyright Doug Hillman 1999 Issuance of Note Discounted on Face Value l At issuance ›Increase Cash for face value less discount ›Increase Discount on Notes Payable for discount ›Increase Notes Payable for face value

14 © Copyright Doug Hillman 1999 Issuance of Note Discounted on Face Value l At maturity ›Increase Interest Expense for discount ›Decrease Discount on Notes Payable for discount ›Decrease Notes Payable for face value ›Decrease Cash for face value

15 © Copyright Doug Hillman 1999 Effective Interest Calculation Effective Interest Rate Discount Net Proceeds 360 Term of Note = X

16 © Copyright Doug Hillman 1999 End of Period Adjustments l Notes written in one accounting period and maturing in a later period require adjustment to accrue interest l Calculate interest from date of note to period ending date

17 © Copyright Doug Hillman 1999 Notes Receivable l Receipt of note for sale ›Record normal sale entry ›Transfer amount from Accounts Receivable to Notes Receivable l Receipt of note in settlement of open account ›Transfer amount from Accounts Receivable to Notes Receivable

18 © Copyright Doug Hillman 1999 Discounting Customers Note l Determine maturity value l Find discount period bank will hold note l Compute discount by multiplying maturity value by discount rate l Deduct discount from maturity value to determine proceeds

19 © Copyright Doug Hillman 1999 Discounting Customers Note l Payee is contingently liable for note if maker does not pay at maturity l Notes Receivable Discounted used to indicate contingent liability l Presentation Notes Receivable$1,000 Deduct: N/R discounted400 Net Notes Receivable$600

20 © Copyright Doug Hillman 1999 Analyzing Information l Determine the availability and adequacy of credit sources l What percent of credit line used up at balance sheet date? l When does the line expire? l Is it likely to be renewed? l Are any credit line requirements not being met? l Is credit line sufficient?