Chapter 16 Short-Term Business Financing © 2003 John Wiley and Sons

2 Chapter Outcomes n Identify and describe strategies for financing working capital. n Identify and briefly explain the factors that affect short-term financing requirements. n Identify the types of unsecured loans made by commercial banks to business borrowers. n Describe the use of accounts receivable, inventory, and other sources of security for bank loans.

3 n Explain the characteristics, terms, and costs of trade credit. n Explain the role of commercial finance companies, factors, Small Business Administration, and commercial paper in providing short-term business financing. Chapter Outcomes, continued

4 Strategies for Financing Working Capital n Working capital n Net working capital n NWC and financing strategy –If NWC>0 $ of current assets financed with long- term funds –If NWC<0 $ of fixed assets financed with current liabilities

5 Another way to look at a firm’s assets... n Fixed Assets n Permanent current assets n Temporary current assets n Asset levels fluctuate over time for a firm

6 Asset Trends for a Growing Firm Assets ($) Time Fixed Assets Permanent Current Assets Temporary or Fluctuating Current Assets

7 Asset Trends for a Growing Firm: Maturity Matching Assets ($) Time Fixed Assets Permanent Current Assets Temporary or Fluctuating Current Assets Long-term financing Short-term financing

8 Asset Trends for a Growing Firm: Aggressive Financing Assets ($) Time Fixed Assets Permanent Current Assets Temporary or Fluctuating Current Assets Long-term financing Short-term financing

9 Asset Trends for a Growing Firm: Conservative Financing Assets ($) Time Fixed Assets Permanent Current Assets Temporary or Fluctuating Current Assets Long-term financing Short-term financing

10 Basic Financing Strategies n Maturity matching n Aggressive n Conservative

11 Financing Strategy Problems n Over-reliance on short-term debt –Exposure to increases in short- term rates –Difficulties in rolling over debt –Forced to acquire long-term financing at inopportune times

12 Problems Not Caused by Financing Strategy n Dot coms –Market ignored cash flow generation—or lack thereof! n Ethical lapses

13 Influences on the short-term/ long-term financing decision n Industry and Company Factors –Ratios of short-term financing to assets AT&T15.4% Consolidated Edison13.3 ExxonMobil25.6 General Motors 20.5 Microsoft18.7 Sears42.8 Walgreens34.1 Walmart37.1

14 Influences on the short-term/ long-term financing decision n Current assets/total assets relationship n Growth n Seasonal variation n Firm life cycle/sales trends

15 Patterns of Short-Term and Long-Term Financing over Time Pattern of Short-Term Financing Pattern of Long-Term Financing Time $ 0 $ 0

16 Influences on the short-term/ long-term financing decision n Cyclical variation n Other influences –Flexibility –Relationship with short-term lenders –Concern over constant debt rollover, exposure to interest rate spikes

17 Commercial Bank Lending n Line of Credit n Revolving Credit Agreement n Accounts Receivable Financing

18 Line of Credit n Clean up period n Periodic re-approval n Compensating balance versus fees

19 Computing interest rates n EAR = (1 + APR/m) m - 1 n $10,000 loan, 6 months, 8%APR n EAR = (1 +.08/2) = 8.16%

20 Discounted Loans n Discounted loan $ received = loan amount - interest = $10,000 - $400 = $9600 Periodic rate = $400/9600 APR = 8.51% n Loan request = funds needed 1 - discount %

21 Revolving Credit Agreement n Commitment by bank n Charge on unused funds

22 Accounts Receivable Financing n Pledging receivables –<80 percent of AR value n Interest rate + fees

23 Inventory Loans n Percent of value lent depends on inventory characteristics n Blanket inventory loan n Trust receipt n Warehouse receipt

24 Technology in Short-term Financing n Digital writing/recording devices (e.g., digital cameras) n B2B auction sites for surplus goods

25 Loans can be secured by... n Stock and bonds n Cash value of life insurance policy n Co-signer n Acceptances

26 Trade Credit n Net date n Trade discounts 2/10 net 30 n Cost of trade credit Pay $98 within 10 days or pay $100 within 30 days Cost: extra $2 for delaying 20 days

27 Cost of Trade Credit n Cost: extra $2 on a $98 charge for delaying 20 days n Approx. effective cost = 2/98 x 365/20 = 37.2% General formula: Percent discount x days 100%-discount % net days-discount days

28 Commercial Finance Companies n Organization without a bank charter that advances funds to businesses –discounts receivables –secured machinery loans –inventory loans –leases n Higher cost than bank loans

29 Factors n Purchases receivables and assumes credit risk n Can supplement or replace a firm’s credit department n Two types of factoring: –maturity factoring –advance factoring n Cost: interest plus charges

30 Other sources n Small business: –SBA guaranteed loans n Large business: –commercial paper –Sold via broker, dealer, electronic trading system –proceeds = issue size less interest less placement fees