short term financing policies

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SHORT TERM FINANCING

POLICIES

PRESENTED BY:

HASSAN NOOR

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SCHEME OF PRESENTATION

INTRODUCTION

SHORT TERM VS LONG TERM FINANCING

SELECTION PROCESS

TYPES OF SHORT TERM FINANCING

EFFECT OF LOAN TERMS ON EFFECTIVE INTEREST RATE

COLATERAL FOR SHORT TERM FINANCING

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INTRODUCTION

Short Term Financing:

It includes all financial products and techniques acompany may use to raise the cash needed within ayear or less.

Need For Financing:

a. Growth: Profits may not be higher enough to keep up at which they are buying new assets.

b. Choice: Rather than save money, firms borrow money to make their purchases.

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S.TERM VS L.TERM

FINANCING5

S.TERM VS L.TERM FINANCING

SHORT TERM

Cheaper than long term

Lower interest rates

Which pushes firms towards short term financing

If the rates go down you are not locked into a high rate for a long term.

LONG TERM

Less risky than short term

Borrower interest cost are certain

Borrower does not have to incur transaction cost

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EXTERNAL FINANCING SOURCE SELECTION PROCESS

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Determining the need

Considerations

Selecting the source

TYPES OF SHORT TERM FINANCING

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Loans From Bank And Other Institution

Commercial Paper

Trade Credit

TYPES OF SHORT TERM FINANCING

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LOANS FROM BANK

Two types of short term loans are:

Self-Liquidating: the one in which proceeds of loan are used to acquire assets that generate cash to repay.

Line Of Credit: The borrowing limit a bank sets for a firm.

Revolving Credit Agreement: a formal agreement between a bank and borrower to extend credit up to a certain amount for some time period.

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TRADE CREDIT

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TRADE CREDIT

DEF:

The act of obtaining funds by delaying payments to suppliers.

Cost Of Trade Credit: Trade credit effective annual interest rate formula is:

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𝑘 = 1 +𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡 %

100−𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡 %

365

𝑑𝑎𝑦𝑠 𝑡𝑜 𝑝𝑎𝑦 −𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑝𝑒𝑟𝑖𝑜𝑑- 1

COMMERCIAL PAPER

DEF:

Unsecured notes issued by large, very credit worthy firms for up to 270 days. It is a cheaper alternative to getting a short term loan from a bank.

Cost Of Commercial Paper:

1. Compute discount from face value;

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360

DTGParDYD

𝐷𝑌 =𝑝𝑎𝑟 𝑣𝑎𝑙𝑢𝑒 −𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒 𝑝𝑟𝑖𝑐𝑒

𝑝𝑎𝑟 𝑣𝑎𝑙𝑢𝑒

360

𝑑𝑎𝑦𝑠 𝑡𝑜 𝑚𝑎𝑡𝑢𝑟𝑖𝑡𝑦

CONT…

2. Compute price of commercial paper;

3. Compute effective annual interest rate;

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DParice Pr

𝐸𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝐴𝑛𝑛𝑢𝑎𝑙 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 =𝑝𝑎𝑟

𝑝𝑟𝑖𝑐𝑒

365𝐷𝑇𝐺

− 1

EFFECT OF LOAN TERMS ON

EFFECTIVE INTEREST RATE 15

EFFECT OF LOAN TERMS ON EFFECTIVE INTEREST RATE Simple Effective Interest Rate:

Loans having same effective interest rate as stated rate of interest.

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use get toYou $

pay $k

youInterest

DISCOUNT LOANS

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DISCOUNT LOANS

Discount Loans:

Loans in which interest is to be paid up front,at the time the loan is made, rather than atmaturity. In this the borrower receives the principleamount minus the interest owed. As a resulteffective interest rate is higher.

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But what does that mean?

CONT…

Compensating Balances:

The loan term which specifies that while loan isoutstanding, the borrower must keep some minimumbalance in a checking account at the lender institution.

The amount required is called compensatingbalance. So, effective interest rate is higher.

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LOAN MATURITIES SHORTER THAN ONE

YEAR The effective annual interest rate of loan with maturities less than one year is calculated as:

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k = 1 +$ 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑦𝑜𝑢 𝑝𝑎𝑦

$ 𝑦𝑜𝑢 𝑔𝑒𝑡 𝑡𝑜 𝑢𝑠𝑒

𝑙𝑜𝑎𝑛 𝑝𝑒𝑟𝑖𝑜𝑑𝑠 𝑖𝑛 𝑦𝑒𝑎𝑟𝑠

COLLATERAL FOR SHORT TERM LOANS

The promissory note that specifies the terms of theloan often includes the type of a collateral used to securethe loan.

Lenders require short term assets as collateralbecause they are more liquid. The major types of shortterm assets used for collateral are:

Accounts receivable as collateral

Inventory as collateral

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EXAMPLE

Suppose you borrow $5000 for one week, and banksconditions are 8% interest collected on discount basis with10% compensating balance. What is effective annualinterest rate of this loan?

(answer: 9.3% )

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Q & ANSWER WE ENCOURAGE YOU TO ASK.

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