15-1​ ​Background​ ​on​ ​Working​ ​Capital

Wednesday,​ ​November​ ​22,​ ​2017

10:25​ ​AM
1. Working​ ​Capital​ ​-​ ​current​ ​assets​ ​are​ ​often​ ​called​ ​working​ ​capital​ ​because​ ​these​ ​assets​ ​"turn
over"
2. Net​ ​Working​ ​Capital​ ​=​ ​Current​ ​Assets-​ ​Current​ ​Liability
3. Net​ ​Operating​ ​Working​ ​Capital​ ​-​ ​Working​ ​capital​ ​used​ ​for​ ​operating​ ​purchases.
NOWC=​ ​Current​ ​Assets-​ ​(Current​ ​Liabilities​ ​-​ ​Notes​ ​Payable)

15-2​ ​Current​ ​Assets​ ​Investment​ ​Policies

Wednesday,​ ​November​ ​22,​ ​2017
10:32​ ​AM
Relaxed​ ​Investment​ ​Policy-​ ​Relatively​ ​large​ ​amounts​ ​of​ ​cash,​ ​marketable​ ​securities,​ ​and​ ​inventories​ ​are
carried,​ ​and​ ​ ​liberal​ ​credit​ ​policy​ ​results​ ​in​ ​a​ ​high​ ​level​ ​of​ ​receivables.

Minimizes​ ​the​ ​firm​ ​risk​ ​from​ ​restricted,​ ​but​ ​lowers​ ​the​ ​turnover,​ ​which​ ​lowers​ ​ROE

Restricted​ ​Investment​ ​Policy-​ ​Holdings​ ​of​ ​cash,​ ​marketable​ ​securities,​ ​inventories,​ ​and​ ​receivables​ ​are
constrained.

(Lean-and-mean​ ​policy)​ ​=​ ​ ​Low​ ​Level​ ​of​ ​assets​ ​=​ ​High​ ​TATO​ ​=​ ​High​ ​ROE
This​ ​policy​ ​exposes​ ​firm​ ​to​ ​risk.

Moderate​ ​Investment​ ​Policy-​ ​An​ ​investment​ ​policy​ ​that​ ​is​ ​between​ ​the​ ​relaxed​ ​and​ ​restricted​ ​policies.

Falls​ ​between​ ​the​ ​two​ ​extremes.

Maximizes​ ​firm's​ ​long-run​ ​earnings​ ​and​ ​the​ ​stock's​ ​intrinsic​ ​value.

ROE=​ ​Profit​ ​Margin​ ​*​ ​Total​ ​Assets​ ​Turnover​ ​*​ ​Equity​ ​Multiplier
=​​ ​Net​ ​Income​​ ​*​ ​ ​Sales​ ​ ​*​ ​ ​Assets
Sales Assets Equity

15-3​ ​Current​ ​Assets​ ​Financing​ ​Policies

Wednesday,​ ​November​ ​22,​ ​2017
10:48​ ​AM
● Primary​ ​sources​ ​of​ ​funds:​ ​Bank​ ​loans,​ ​credit​ ​from​ ​suppliers,​ ​accrued​ ​liabilities,​ ​long-term​ ​debt,
and​ ​common​ ​equity.
● Each​ ​source​ ​has​ ​advantages​ ​and​ ​disadvantages.
Permanent​ ​Current​ ​Assets-​ ​Current​ ​assets​ ​that​ ​a​ ​firm​ ​must​ ​carry​ ​even​ ​at​ ​the​ ​trough​ ​of​ ​its​ ​cycles.
Temporary​ ​Current​ ​Assets-​ ​Current​ ​assets​ ​with​ ​seasonal​ ​or​ ​cyclical​ ​variations​ ​in​ ​sales.
Current​ ​Assets​ ​Financing​ ​Policy-​ ​The​ ​manner​ ​in​ ​which​ ​current​ ​assets​ ​are​ ​financed.

15-3A​ ​Maturity,​ ​Matching,​ ​or​ ​"Self-liquidating",​ ​Approach

Maturity​ ​Matching,​ ​or​ ​"self-liquidating,"​ ​approach-​ ​A​ ​financing​ ​policy​ ​that​ ​matches​ ​the​ ​maturities​ ​of
assets​ ​and​ ​liabilities,​ ​this​ ​is​ ​a​ ​moderate​ ​policy.

● All​ ​fixed​ ​assets​ ​and​ ​permanent​ ​current​ ​assets​ ​and​ ​are​ ​financed​ ​with​ ​long-term​ ​capital.
● Temporary​ ​current​ ​assets​ ​are​ ​financed​ ​with​ ​short-term​ ​debt.
○ These​ ​short​ ​terms​ ​are​ ​set​ ​equal​ ​to​ ​their​ ​own​ ​life
Two​ ​factors​ ​prevent​ ​an​ ​exact​ ​maturity​ ​matching
1. There​ ​is​ ​uncertainty​ ​about​ ​the​ ​lives​ ​of​ ​assets.
2. Some​ ​common​ ​equity​ ​must​ ​be​ ​used,​ ​and​ ​common​ ​equity​ ​has​ ​no​ ​maturity.

15-3B​ ​Aggressive​ ​Approach

● The​ ​figure​ ​used​ ​shows​ ​relatively​ ​aggressive​ ​because​ ​there​ ​are​ ​different​ ​degrees​ ​of
aggressiveness.
● May​ ​end​ ​of​ ​drawing​ ​the​ ​permanent​ ​level​ ​of​ ​current​ ​assets​ ​below​ ​the​ ​fixed​ ​assets​ ​line.​ ​Although
risky,​ ​the​ ​short​ ​term​ ​loans​ ​have​ ​lower​ ​interest​ ​rates​ ​and​ ​some​ ​firms​ ​are​ ​willing​ ​to​ ​take​ ​this​ ​risk.

Overall,​ ​it​ ​is​ ​not​ ​possible​ ​to​ ​state​ ​that​ ​long-term​ ​or​ ​short-term​ ​financing​ ​is​ ​better​ ​than​ ​the​ ​other.​ ​The
firm's​ ​specific​ ​conditions​ ​will​ ​affect​ ​the​ ​choice​ ​as​ ​will​ ​the​ ​preference​ ​of​ ​management.

15-4​ ​The​ ​Cash​ ​Conversion​ ​Cycle

Wednesday,​ ​November​ ​22,​ ​2017
10:47​ ​AM
Cash​ ​Conversion​ ​Cycle​ ​(CCC)​ ​-​ ​ ​The​ ​length​ ​of​ ​time​ ​funds​ ​are​ ​tied​ ​up​ ​in​ ​working​ ​capital,​ ​or​ ​the​ ​length​ ​of
time​ ​between​ ​paying​ ​for​ ​working​ ​capital​ ​and​ ​collecting​ ​cash​ ​from​ ​the​ ​sale​ ​of​ ​the​ ​working​ ​capital.

15-4A​ ​Calculating​ ​the​ ​Targeted​ ​CCC

1. Inventory​ ​conversion​ ​period-​ ​The​ ​average​ ​time​ ​required​ ​to​ ​convert​ ​raw​ ​materials​ ​into​ ​finished
goods​ ​and​ ​then​ ​to​ ​sell​ ​them.
 2. Average​ ​collection​ ​period​ ​(ACP)​ ​-​ ​The​ ​average​ ​length​ ​of​ ​time​ ​required​ ​to​ ​convert​ ​the​ ​firm's
receivables​ ​into​ ​cash,​ ​that​ ​is,​ ​to​ ​collect​ ​cash​ ​following​ ​sales.
3. Payables​ ​Deferral​ ​Period-​ ​The​ ​average​ ​length​ ​of​ ​time​ ​between​ ​the​ ​purchase​ ​of​ ​materials​ ​and
labor​ ​and​ ​the​ ​payment​ ​of​ ​cash​ ​for​ ​them.

ICP​ ​+​ ​ACP​ ​-​ ​PDP​ ​=​ ​CCC

15-4B​ ​Calculating​ ​the​ ​CCC​ ​From​ ​Financial​ ​Statements

Inventory​ ​Conversion​ ​Period​ ​=​ ​ ​Inventory
​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​COGS/Day
Average​ ​Collection​ ​period=​ ​ACP​ ​(or​ ​DSO)​ ​=​ ​Receivables
​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​Sales/365
Payables​ ​Deferral​ ​Period​ ​= Payables = Payables
​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​Purchases​ ​per​ ​day​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​COGS/365

15-5​ ​The​ ​Cash​ ​Budget

Wednesday,​ ​November​ ​22,​ ​2017
10:54​ ​AM
Cash​ ​budget-​ ​a​ ​table​ ​that​ ​shows​ ​cash​ ​receipts,​ ​disbursements,​ ​and​ ​balances​ ​over​ ​some​ ​period.
● Firms​ ​typically​ ​develop​ ​a​ ​monthly​ ​cash​ ​budget​ ​for​ ​the​ ​coming​ ​year​ ​and​ ​a​ ​daily​ ​cash​ ​budget​ ​at
the​ ​start​ ​of​ ​each​ ​month
● Monthly​ ​budget​ ​is​ ​good​ ​for​ ​annual​ ​planning
● Daily​ ​budget​ ​gives​ ​more​ ​precise​ ​pictures​ ​of​ ​the​ ​actual​ ​cash​ ​flows.
Target​ ​Cash​ ​Balance-​ ​The​ ​desired​ ​cash​ ​balance​ ​that​ ​a​ ​firm​ ​plans​ ​to​ ​maintain​ ​in​ ​order​ ​to​ ​conduct
business.

15-6​ ​Cash​ ​and​ ​Marketable​ ​Securities

Wednesday,​ ​November​ ​22,​ ​2017
11:50​ ​AM
● "Cash"​ ​on​ ​balance​ ​sheets​ ​generally​ ​include​ ​"Cash-equivalents"​ ​such​ ​as​ ​short-term​ ​securities.

Firm's​ ​Marketable​ ​security​ ​holdings​ ​divided​ ​into​ ​two​ ​categories.

1. Operating​ ​short-term​ ​securities;​ ​held​ ​primarily​ ​to​ ​provide​ ​liquidity​ ​and​ ​are​ ​bought​ ​and​ ​sold​ ​as
needed​ ​to​ ​provide​ ​funds​ ​for​ ​operations
2. Other​ ​short-term​ ​securities;​ ​holdings​ ​in​ ​excess​ ​of​ ​the​ ​amount​ ​needed​ ​to​ ​support​ ​normal
operations.

● Highly​ ​profitable​ ​firms​ ​hold​ ​far​ ​more​ ​securities​ ​than​ ​are​ ​needed​ ​for​ ​liquidity​ ​purposes.
15-6A​ ​Currency
Now​ ​credit​ ​cards​ ​are​ ​everywhere​ ​so​ ​even​ ​for​ ​retailers,​ ​currency​ ​generally​ ​represents​ ​a​ ​small​ ​part​ ​of​ ​total
cash​ ​holdings.

15-6B​ ​Demand​ ​Deposits

● Checking​ ​deposits​ ​used​ ​for​ ​transactions;​ ​however,​ ​they​ ​typically​ ​earn​ ​no​ ​interest​ ​so​ ​firms​ ​try​ ​to
minimize​ ​their​ ​holdings​ ​while​ ​still​ ​ensuring​ ​they​ ​are​ ​able​ ​to​ ​pay​ ​suppliers​ ​promptly

Following​ ​techniques​ ​are​ ​to​ ​optimize​ ​demand​ ​deposit​ ​holdings:

1. Hold​ ​marketable​ ​securities​ ​rather​ ​than​ ​demand​ ​deposits​ ​to​ ​provide​ ​liquidity-​ ​When​ ​holding
marketable​ ​securities​ ​the​ ​need​ ​for​ ​demand​ ​deposits​ ​is​ ​reduced.
2. Borrow​ ​on​ ​short​ ​notice-​ ​Can​ ​establish​ ​lines​ ​of​ ​credit​ ​that​ ​can​ ​be​ ​borrowed​ ​with​ ​just​ ​a​ ​phone​ ​call,
but​ ​these​ ​could​ ​have​ ​fees​ ​that​ ​need​ ​to​ ​be​ ​considered.
3. Forecast​ ​payments​ ​and​ ​receipts​ ​better-​ ​the​ ​better​ ​the​ ​firm​ ​can​ ​forecast​ ​its​ ​cash​ ​inflows​ ​and
outflows,​ ​the​ ​smaller​ ​its​ ​needs​ ​for​ ​funds​ ​to​ ​meet​ ​unexpected​ ​requirements.​ ​Improving​ ​the
inflow/outflow​ ​forecasts​ ​lessens​ ​the​ ​need​ ​to​ ​hold​ ​liquid​ ​assets​ ​and​ ​thus​ ​reduces​ ​the​ ​required
amount​ ​of​ ​working​ ​capital
4. Speed​ ​up​ ​payments-​ ​take​ ​actions​ ​to​ ​obtain​ ​cash​ ​receipts​ ​faster.
1. Lockboxes-​ ​Post​ ​office​ ​boxes​ ​operated​ ​by​ ​a​ ​bank​ ​to​ ​which​ ​payments​ ​are​ ​sent.​ ​Used​ ​to
speed​ ​up​ ​effective​ ​receipt​ ​of​ ​cash.
5. Use​ ​credit​ ​cards,​ ​debit​ ​cards,​ ​wire​ ​transfers,​ ​and​ ​direct​ ​deposits-​ ​increases​ ​free​ ​cash​ ​flows​ ​and
reduces​ ​required​ ​cash​ ​holdings
6. Synchronize​ ​cash​ ​flows-​ ​will​ ​reduce​ ​need​ ​for​ ​cash​ ​balances.​ ​Set​ ​the​ ​inflows​ ​equal​ ​to​ ​the​ ​outflows
kind​ ​of​ ​thing

15-6C
● Marketable​ ​securities​ ​held​ ​for​ ​operations​ ​are​ ​managed​ ​in​ ​conjunction​ ​with​ ​demand​ ​deposits--
the​ ​management​ ​of​ ​one​ ​requires​ ​coordination​ ​with​ ​the​ ​other.
● Purchas​ ​marketable​ ​securities​ ​as​ ​cash​ ​buildups​ ​and​ ​sell​ ​when​ ​they​ ​need​ ​cash.
● A​ ​trade-off​ ​between​ ​risk​ ​and​ ​return​ ​is​ ​involved--​ ​firm​ ​wants​ ​to​ ​earn​ ​high​ ​returns,​ ​but​ ​marketable
securities​ ​are​ ​held​ ​to​ ​provide​ ​liquidity.​ ​Treasurers​ ​want​ ​to​ ​hold​ ​securities​ ​that​ ​can​ ​be​ ​sold​ ​very
quickly​ ​at​ ​a​ ​known​ ​price.
● So​ ​called​ ​"safe​ ​securities"​ ​don’t​ ​always​ ​end​ ​up​ ​being​ ​safe
● If​ ​firm​ ​has​ ​good​ ​standing​ ​with​ ​its​ ​bank​ ​where​ ​it​ ​can​ ​get​ ​money​ ​quickly​ ​it​ ​does​ ​not​ ​have​ ​much
need​ ​for​ ​liquid​ ​reserves.
 ● Buy​ ​world​ ​round​ ​which​ ​tend​ ​to​ ​equalize​ ​world-wide​ ​rates.

15-7​ ​Inventories
Friday,​ ​November​ ​24,​ ​2017
2:29​ ​PM
Inventories​ ​can​ ​include:
1. Supplies
2. Raw​ ​materials
3. Work​ ​in​ ​process
4. Finished​ ​goods
Essential​ ​part​ ​of​ ​virtually​ ​all​ ​business​ ​operations.
● Sales​ ​must​ ​be​ ​forecasted​ ​before​ ​target​ ​inventories​ ​can​ ​be​ ​established
● Although​ ​important,​ ​it​ ​is​ ​under​ ​the​ ​operational​ ​control​ ​of​ ​production​ ​managers​ ​and​ ​marketing
people​ ​rather​ ​than​ ​financial​ ​managers.​ ​But​ ​used​ ​in​ ​3​ ​ways:
1. Expensive​ ​to​ ​install​ ​and​ ​maintain​ ​the​ ​computer​ ​systems​ ​and​ ​the​ ​capital​ ​budgeting​ ​analysis​ ​must
be​ ​used​ ​to​ ​determine​ ​which​ ​system​ ​is​ ​best.
2. If​ ​firm​ ​chooses​ ​to​ ​increase​ ​its​ ​inventory​ ​holdings,​ ​the​ ​financial​ ​manager​ ​must​ ​raise​ ​the​ ​capital
needed​ ​to​ ​acquire​ ​the​ ​additional​ ​inventory.
3. Financial​ ​manager​ ​is​ ​responsible​ ​for​ ​identifying​ ​any​ ​area​ ​of​ ​weakness​ ​that​ ​affects​ ​the​ ​firm's
overall​ ​profitability,​ ​using​ ​ratios​ ​and​ ​other​ ​procedures​ ​for​ ​comparing​ ​the​ ​firm​ ​to​ ​its​ ​benchmark
companies.

15-8​ ​Accounts​ ​Receivable

Friday,​ ​November​ ​24,​ ​2017
2:44​ ​PM
● The​ ​firm's​ ​credit​ ​policy​ ​is​ ​the​ ​primary​ ​determinant​ ​of​ ​accounts​ ​receivable,​ ​and​ ​it​ ​is​ ​under​ ​the
administrative​ ​control​ ​of​ ​the​ ​CFO

15-8A​ ​Credit​ ​Policy

Credit​ ​Policy-​ ​A​ ​set​ ​of​ ​rules​ ​that​ ​include​ ​the​ ​firm's​ ​credit​ ​period,​ ​discounts,​ ​credit​ ​standards,​ ​and
collection​ ​procedures​ ​offered.
1. Credit​ ​period-​ ​the​ ​length​ ​of​ ​time​ ​customers​ ​have​ ​to​ ​pay​ ​for​ ​purchases.
2. Discounts-​ ​Price​ ​reductions​ ​given​ ​for​ ​early​ ​payment
3. Credit​ ​Standards-​ ​the​ ​financial​ ​strength​ ​customers​ ​must​ ​exhibit​ ​to​ ​qualify​ ​for​ ​credit
4. Collection​ ​Policy-​ ​degree​ ​of​ ​toughness​ ​in​ ​enforcing​ ​the​ ​credit​ ​terms

Credit​ ​terms-​ ​Statement​ ​of​ ​the​ ​credit​ ​period​ ​and​ ​discount​ ​policy.
15-8B​ ​Setting​ ​and​ ​Implementing​ ​the​ ​Credit​ ​Policy
Credit​ ​policy​ ​is​ ​important​ ​for​ ​three​ ​main​ ​reasons:
1. It​ ​has​ ​a​ ​major​ ​effect​ ​on​ ​sales.
2. It​ ​influences​ ​the​ ​amount​ ​of​ ​funds​ ​tied​ ​up​ ​in​ ​receivables
3. It​ ​affects​ ​bad​ ​debt​ ​losses.

Due​ ​to​ ​importance​ ​the​ ​firm's​ ​executive​ ​committee​ ​has​ ​final​ ​say.​ ​Once​ ​set​ ​into​ ​play​ ​the​ ​credit​ ​manager,
typically​ ​under​ ​the​ ​CFO,​ ​must​ ​implement​ ​and​ ​monitor​ ​its​ ​effects.
Reports​ ​include​ ​the​ ​following​ ​types​ ​of​ ​information:
1. A​ ​summary​ ​balance​ ​sheet​ ​and​ ​income​ ​statement.
2. A​ ​number​ ​of​ ​key​ ​ratios​ ​with​ ​trend​ ​information.
3. Data​ ​obtained​ ​from​ ​the​ ​firm's​ ​suppliers​ ​telling​ ​whether​ ​it​ ​pays​ ​promptly​ ​or​ ​slowly​ ​and​ ​whether
it​ ​has​ ​recently​ ​railed​ ​to​ ​make​ ​any​ ​payments.
4. A​ ​verbal​ ​description​ ​of​ ​the​ ​physical​ ​condition​ ​of​ ​the​ ​firm's​ ​operations.
5. A​ ​verbal​ ​description​ ​of​ ​the​ ​backgrounds​ ​of​ ​the​ ​firm's​ ​owners,​ ​including​ ​any​ ​previous
bankruptcies,​ ​lawsuits,​ ​or​ ​divorce​ ​settlement​ ​problems.
6. A​ ​summary​ ​rating​ ​ranging​ ​from​ ​A​ ​for​ ​the​ ​best​ ​credit​ ​risks​ ​down​ ​to​ ​F​ ​for​ ​those​ ​firms​ ​that​ ​are
deemed​ ​likely​ ​to​ ​default.

Credit​ ​scores-​ ​Numerical​ ​scores​ ​that​ ​indicate​ ​the​ ​likelihood​ ​that​ ​people​ ​or​ ​businesses​ ​will​ ​pay​ ​on​ ​time.

**​ ​If​ ​it​ ​is​ ​possible​ ​to​ ​sell​ ​on​ ​credit​ ​and​ ​to​ ​impose​ ​a​ ​carrying​ ​charge​ ​on​ ​the​ ​receivables​ ​that​ ​are
outstanding,​ ​credit​ ​sales​ ​can​ ​actually​ ​be​ ​more​ ​profitable​ ​than​ ​cash​ ​sales.

15-8C
Accounts​ ​receivable​ ​=​ ​Sales​ ​per​ ​day​ ​*​ ​Length​ ​of​ ​collection​ ​period
DSO=​ ​Days​ ​sales​ ​outstanding​ ​=​ ​Receivables​ ​/​ ​Average​ ​sales​ ​per​ ​day​ ​=​ ​Receivables​ ​/(Annual​ ​Sales/365)
Receivables​ ​=(Average​ ​Sales​ ​per​ ​day)(DSO)

15-9​ ​Accounts​ ​Payable​ ​(Trade​ ​Credit)

Friday,​ ​November​ ​24,​ ​2017
3:12​ ​PM
Trade​ ​Credit-​ ​Debt​ ​arising​ ​from​ ​credit​ ​sales​ ​and​ ​recorded​ ​as​ ​an​ ​account​ ​receivable​ ​by​ ​the​ ​seller​ ​and​ ​as
an​ ​account​ ​payable​ ​by​ ​the​ ​buyer.
List​ ​Price​ ​=​ ​"True"​ ​price​ ​+​ ​Finance​ ​Charge
Nominal​ ​Annual​ ​Cost​ ​of​ ​Trade​ ​Credit​ ​=​ ​(Discount​ ​%)(365)/(100-Discount%)(Days​ ​Credit​ ​is​ ​outstanding​ ​-
Discount​ ​Period)

Two​ ​types​ ​of​ ​trade​ ​credit:

1. Free​ ​Trade​ ​Credit​ ​-​ ​credit​ ​received​ ​during​ ​the​ ​discount​ ​period,​ ​the​ ​trade​ ​credit​ ​that​ ​is​ ​obtained
without​ ​a​ ​cost,​ ​and​ ​it​ ​is​ ​without​ ​forgoing​ ​discounts.
2. Costly​ ​Trade​ ​Credit-​ ​Credit​ ​taken​ ​in​ ​excess​ ​of​ ​free​ ​trade​ ​credit,​ ​whose​ ​cost​ ​is​ ​equal​ ​to​ ​the
discount​ ​lost,​ ​any​ ​trade​ ​credit​ ​over​ ​and​ ​above​ ​the​ ​free​ ​trade​ ​credit.

**Firms​ ​should​ ​always​ ​use​ ​the​ ​free​ ​component,​ ​but​ ​they​ ​should​ ​use​ ​the​ ​costly​ ​component​ ​only​ ​if​ ​they
cannot​ ​obtain​ ​funds​ ​at​ ​a​ ​lower​ ​cost​ ​from​ ​another​ ​source.

15-10​ ​Bank​ ​Loans

Friday,​ ​November​ ​24,​ ​2017
3:21​ ​PM
Key​ ​features​ ​of​ ​bank​ ​loans​ ​are​ ​discussed​ ​here.

15-10A​ ​Promissory​ ​Note

Promissory​ ​Note-​ ​A​ ​document​ ​specifying​ ​the​ ​terms​ ​and​ ​conditions​ ​of​ ​a​ ​loan,​ ​including​ ​the​ ​amount,
interest​ ​rate,​ ​and​ ​repayment​ ​schedule.
1. Amount-​ ​The​ ​amount​ ​borrowed​ ​is​ ​indicated
2. Maturity-​ ​bulk​ ​of​ ​banks​ ​lending​ ​are​ ​on​ ​short-term​ ​basis,​ ​since​ ​banks​ ​usually​ ​don't​ ​demand
payment​ ​unless​ ​the​ ​borrower's​ ​credit​ ​worthiness​ ​has​ ​deteriorated,​ ​some​ ​"short-term​ ​loans"
remain​ ​outstanding​ ​for​ ​years,​ ​with​ ​the​ ​interest​ ​rate​ ​flowing​ ​with​ ​the​ ​economy.
3. Interest​ ​Rate​ ​-​ ​Interest​ ​rate​ ​can​ ​be​ ​fixed​ ​or​ ​floating.​ ​Indicated​ ​rate​ ​is​ ​nominal​ ​and​ ​it​ ​will​ ​state​ ​if​ ​it
uses​ ​a​ ​360​ ​or​ ​365​ ​day​ ​year.
4. Interest​ ​only​ ​vs.​ ​amortized-​ ​Interest​ ​only,​ ​interest​ ​paid​ ​during​ ​life​ ​with​ ​all​ ​principal​ ​repaid​ ​when
the​ ​loan​ ​matures;​ ​amortized,​ ​some​ ​of​ ​the​ ​principal​ ​is​ ​repaid​ ​each​ ​payment​ ​date.
5. Frequency​ ​of​ ​interest​ ​payments-​ ​If​ ​interest-only​ ​basis​ ​it​ ​will​ ​indicate​ ​how​ ​frequently​ ​the​ ​interest
must​ ​be​ ​paid.​ ​Usually​ ​calculated​ ​daily,​ ​but​ ​paid​ ​monthly
6. Discount​ ​Interest-​ ​Most​ ​loans​ ​call​ ​for​ ​interest​ ​to​ ​be​ ​paid​ ​only​ ​after​ ​it​ ​has​ ​been​ ​earned;​ ​but
discount​ ​basis​ ​means​ ​interest​ ​is​ ​paid​ ​in​ ​advance,​ ​borrower​ ​actually​ ​receives​ ​less​ ​than​ ​face
amount​ ​of​ ​the​ ​loan.
7. Add-on​ ​loans-​ ​Interest​ ​charges​ ​and​ ​then​ ​added​ ​to​ ​the​ ​face​ ​amount​ ​of​ ​the​ ​loan.
8. Collateral​ ​-​ ​If​ ​loan​ ​is​ ​secured​ ​by​ ​equipment..​ ​Etc.
9. Restrictive​ ​Covenants​ ​-​ ​Note​ ​may​ ​specify​ ​that​ ​the​ ​borrower​ ​must​ ​maintain​ ​certain​ ​ratios​ ​or​ ​the
interest​ ​rate​ ​goes​ ​up​ ​or​ ​the​ ​lender​ ​gets​ ​payment​ ​immediately.
10. Loan​ ​guarantees-​ ​banks​ ​protect​ ​themselves​ ​by​ ​insisting​ ​that​ ​larger​ ​stockholders​ ​personally
guarantee​ ​the​ ​loan.
15-10B​ ​Line​ ​of​ ​Credit
Line​ ​of​ ​credit-​ ​an​ ​arrangement​ ​in​ ​which​ ​a​ ​bank​ ​agrees​ ​to​ ​lend​ ​up​ ​to​ ​a​ ​specified​ ​maximum​ ​amount​ ​of
funds​ ​during​ ​a​ ​designated​ ​period.

15-10C​ ​Revolving​ ​Credit​ ​Agreement

Revolving​ ​credit​ ​agreement-​ ​A​ ​formal,​ ​committed​ ​line​ ​of​ ​credit​ ​extended​ ​by​ ​a​ ​bank​ ​or​ ​other​ ​lending
institution.
● Has​ ​a​ ​legal​ ​obligation​ ​to​ ​honor​ ​the​ ​credit​ ​agreement,​ ​and​ ​it​ ​receives​ ​a​ ​commitment​ ​fee.

15-10D​ ​Costs​ ​of​ ​Bank​ ​Loans

Prime​ ​rate-​ ​A​ ​published​ ​interest​ ​rate​ ​charged​ ​by​ ​commercial​ ​banks​ ​to​ ​large,​ ​strong​ ​borrowers.
Calculating​ ​Banks'​ ​Interest​ ​Charges:​ ​Regular​ ​(or​ ​Simple)​ ​Interest-​ ​the​ ​situation​ ​when​ ​interest​ ​only​ ​is​ ​paid
monthly
Simple​ ​Interest​ ​rate​ ​/​ ​day​ ​=​ ​Nominal​ ​rate​ ​/​ ​days​ ​in​ ​year

Interest​ ​charge​ ​for​ ​month​ ​=​ ​Rate​ ​per​ ​day​ ​*​ ​Amount​ ​of​ ​loan​ ​*​ ​Days​ ​in​ ​month
Calculating​ ​Banks'​ ​Interest​ ​charges​ ​:​ ​Add-on​ ​interest​ ​-​ ​Interest​ ​that​ ​is​ ​calculated​ ​and​ ​added​ ​to​ ​funds
received​ ​to​ ​determine​ ​the​ ​face​ ​amount​ ​of​ ​an​ ​installment​ ​loan

Approximate​ ​annual​ ​rate​ ​(Add-on)​ ​=​ ​Interest​ ​paid/​ ​(Amount​ ​received/​ ​2)

15-11​ ​Commercial​ ​Paper

Friday,​ ​November​ ​24,​ ​2017
3:43​ ​PM
Commercial​ ​Paper-​ ​Unsecured,​ ​short-term​ ​promissory​ ​notes​ ​of​ ​large​ ​firms,​ ​usually​ ​issued​ ​in
denominations​ ​of​ ​$100,000​ ​or​ ​more​ ​with​ ​an​ ​interest​ ​rate​ ​somewhat​ ​below​ ​the​ ​prime​ ​rate
● Sold​ ​primarily​ ​to​ ​other​ ​business​ ​firms,​ ​insurance​ ​companies,​ ​pension​ ​funds,​ ​money​ ​market
mutual​ ​funds,​ ​and​ ​banks.
● Large​ ​majority​ ​of​ ​commercial​ ​paper​ ​outstanding​ ​has​ ​been​ ​issued​ ​by​ ​financial​ ​institutions

15-12​ ​Accruals​ ​(Accrued​ ​Liabilities)

Friday,​ ​November​ ​24,​ ​2017
Accruals-​ ​continually​ ​recurring​ ​short-term​ ​liabilities,​ ​especially​ ​accrued​ ​wages​ ​and​ ​accrued​ ​taxes.
Spontaneous​ ​Funds-​ ​Funds​ ​that​ ​are​ ​generated​ ​spontaneously​ ​as​ ​the​ ​firm​ ​expands.
● Accruals​ ​are​ ​spontaneous​ ​funds
 ● Firms​ ​use​ ​all​ ​accruals​ ​they​ ​can,​ ​but​ ​they​ ​have​ ​little​ ​control​ ​over​ ​their​ ​levels.

15-13​ ​Use​ ​of​ ​Security​ ​in​ ​Short-Term​ ​Financing

Friday,​ ​November​ ​24,​ ​2017
3:48​ ​PM
Secured​ ​loans-​ ​A​ ​loan​ ​backed​ ​by​ ​collateral,​ ​often​ ​inventories​ ​or​ ​accounts​ ​receivables.
● Other​ ​things​ ​held​ ​constant​ ​borrowers​ ​prefer​ ​to​ ​use​ ​unsecured​ ​short-term​ ​debt
● Few​ ​firms​ ​that​ ​need​ ​loans​ ​hold​ ​portfolios​ ​of​ ​stocks​ ​and​ ​bonds
● Land,​ ​building,​ ​and​ ​equipment​ ​are​ ​good​ ​forms​ ​of​ ​collateral;​ ​but​ ​are​ ​generally​ ​used​ ​for​ ​long-term
loans​ ​not​ ​short-term
● Most​ ​short-term​ ​use​ ​accounts​ ​receivable​ ​and​ ​inventories​ ​as​ ​collateral.