Learning Objectives
The need for short-term financing. The advantages and disadvantages of short-term financing. Three types of short-term financing. Computation of the cost of trade credit, commercial paper, and bank loans. How to use accounts receivable and inventory as collateral for short-term loans.
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easier availability usually has lower cost (remember yield curve) matches need for short term assets, like inventory
Trade Credit
Trade credit is the act of obtaining funds by delaying payment to suppliers, who typically grant 30 days to pay. The cost of trade credit may be some interest charge that the supplier charges on the unpaid balance. More often, it is in the form of a lost discount that would be given to firms who pay earlier. Credit has a cost. That cost may be passed along to the customer as higher prices, (furniture sales, Office Max), or borne by the seller as lower profits, or some of both.
Example: You borrow $10,000 from a bank, at a stated rate of 10%, and must pay $1,000 interest at the end of the year. Your effective rate is the same as the stated rate: $1,000/$10,000 = .10 = 10%
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Commercial Paper
Commercial paper is quoted on a discount basis, meaning that the interest is subtracted from the face value to arrive at the price. See 3 steps below for calculation: Step 1: Compute the discount (D) from face value of the commercial paper Discount (D) = (Discount rate x par x DTG)/365 DTG = days to go (to maturity) Step 2: Compute the price = Face value - Discount Step 3: Compute Effective Annual Rate (APR): $ interest you pay/ $ you get to use 15
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Inventory as Collateral
A major problem with inventory financing is valuing the inventory. For this reason, lenders will generally make a loan in the amount of only a fraction of the value of the inventory. The fraction will differ depending on the type of inventory. If inventory is long lived, i.e. lumber, they (lender or a customer) may loan you up to 75% of the resale value. If inventory is perishable, i.e., lettuce, you wont get much 19
The End
The End!
Prof D Students
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