copyright © cengage learning. all rights reserved short-term debt financing short-term financing is...

Copyright © Cengage Learning. All rights reserved

Short-Term Debt Financing

• Short-term financing is usually easier to obtain than long-term

– Shorter repayment period means less risk of nonpayment

– Amounts of short-term loans are smaller than long-term loans

– There is a closer relationship between borrower and lender

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Sources of Unsecured Short-Term Debt Financing

• Unsecured financing– Financing not backed by collateral

• Trade credit– Financing extended by a seller who does not require

immediate payment after the delivery of the merchandise

• Promissory notes– A written pledge by a borrower to pay a certain sum of

money to a creditor at a specified future date

– Unlike trade credit, promissory notes usually include interest

– Legally binding

– Negotiable instruments

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Sources of Unsecured Short-Term Debt Financing (cont’d)

• Unsecured bank loans– Interest rates vary with each borrower’s credit rating

– Prime interest rate• The lowest rate charged by a bank for a short-term loan

– Offered through promissory notes, a line or credit, or revolving credit agreement

• Commercial paper– Short-term promissory note issued by a large corporation

– Interest rates are usually below that charged by banks for short-term loans

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Average Prime Interest Rate

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Source: Federal Reserve Bank website, www.federalreserve.gov, accessed October 17, 2008.


Sources of Secured Short-Term Debt Financing

• Loans secured by inventory– Inventory is pledged as collateral– Control of the inventory passes to the lender until the loan is

repaid– The borrow must pay storage for the inventory– Floor planning

• The title to the inventory is given to lenders in return for short-term financing

• The borrow maintains control of the inventory

• Loans secured by receivables– Amounts owed the firm in the form of accounts receivable from

trade credit given to customers are pledged as collateral– Quality of receivables is considered

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Factoring Accounts Receivable

• Another method of raising short-term financing• Factor

– A firm that specializes in buying other firms’ accounts receivable

• The factor buys accounts receivable for less than their face value

• The factor collects the full dollar amounts when each account is due

• The factor’s profit is the difference between the face value and what it paid for the accounts receivable

• Profit is based on the risk (probability that the accounts receivable will not be paid) the factor assumes

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Comparison of Short-Term Financing Methods

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