1. Chapter 21 Short-Term Financing
Cheng F Lee
Rutgers University, USA
John Lee
Center for PBBEF Research, USA

2. Chapter Outline 21.1 Introduction 21.2 Bank Loans
21.3 Characteristics of bank loans
21.4 Short-Term financing with trade credit
21.5 Turning receivables into cash
21.6 Inventory financing and management
21.7 Nonbank sources of funds
21.8 Summary

3. 21.2 Bank Loans
Commercial banks provide short-term credit to corporations in the following forms:
A. Banks lend short-term funds in the form of self- liquidating loans. That is, the money is loaned for specific purposes and operations that would produce cash flows necessary to pay off the debt quickly.
B. A line of credit is an agreement that specifies the maximum amount of unsecured credit the bank will extend to the firm at any time during the life of the agreement. Besides an interest rate on the used portion of the line of credit, there is a fee on the entire line.

4. 21.2 Bank Loans
C. A revolving credit is an agreement similar to the line of credit with the addition that the borrower may borrow the entire line, pay it off, and then borrow again up to the line of credit without renegotiating the loan.
D. Floor plan loans finance equipment purchases. The lender is the official owner of the equipment and when the company sells the equipment, the lender is paid.

5. 21.3 Characteristics of bank loans
Bank loans include the following terms and restrictions.
A. An interest rate is charged on the loan. The rate may be a variable rate or a fixed rate. The majority of commercial loans have variable rates.
B. The calculation of the interest charge on the loan may be done in a number of ways:
i. The add-on interest method calculates interest on the full amount borrowed over the entire loan period. (A 10% add- on for $1,000 over 3 years is .10(1000)(3)=$300)
ii. The bank discount interest method calculates the interest on the full amount borrowed. The interest is netted out of the loan proceeds (A 10% discount on $1,000 would give the borrower $900).

6. 21.4 Short-Term financing with trade credit
A. A firm may use trade credit as a source of funds for the company.
B. In seasonal industries the use of seasonal dating will delay payment for a company purchasing under these terms, thus providing them a source of funds.

7. 21.5 Turning receivables into cash
A. Receivables may be quickly turned into cash through pledging or factoring the receivables.
i. pledging involves offering receivables as collateral against a short-term loan.
ii. Factoring is an outright sale of the receivables to a lender known as a factor at some negotiated discount.

8. 21.6 Inventory financing and management
Inventory financing includes either trust receipts or warehouse financing.
A. a trust receipt is a lien against the asset. Only a portion of the asset’s value is advanced. When the company sells the asset, the lender is paid and title to the asset is released.
B. warehousing method of financing has two variations: field warehousing and public warehousing.

9. 21.6 Inventory financing and management
B. warehousing method of financing has two variations: field warehousing and public warehousing.
i. in field warehousing the lender takes over the use of a certain part of the borrower’s premises to store the financed inventory. This area is kept locked, restricting access only to the warehousing company.
ii. In public warehousing the lender removes the physical inventory from the borrowing company’s premises and is transferred to and stored in a warehouse operated by an independent warehousing company.

10. 21.7 Nonbank sources of funds
A. commercial paper is an unsecured promissory note with a maturity from 1 to 270 days where the proceeds are used for current transactions.
B. Banker’s acceptances are largely used in financing foreign trade. A draft is drawn on the bank by a foreign exporter. The bank, upon receiving the draft stamps the draft accepted and the draft is transformed into a banker’s acceptance. The bankers’ acceptance is sold to money market investors at a discount.

11. 21.7 Nonbank sources of funds
C. Asset-backed securities are backed by assets of the firm that are transformed to a grantor trust. The trustee receives cash flows off the assets and pays scheduled interest and principal payments to investors, servicing fees to the selling firm and any legal or other expenses. This process is called securitization.