1. Chapter 8 Sources of Short-Term Financing

2. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. PPT 8-1 FIGURE 8-1 The prime rate versus the London Interbank Offered Rate on U.S. dollar deposits

3. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. PPT 8-2 FIGURE 8-2 Total commercial paper outstanding

4. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. PPT 8-3 TABLE 8-1 Comparison of commercial paper rate to prime rate (annual rate)*

5. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Chapter 8 - Outline LT 8-1 Sources of Short-Term Financing Trade Credit Net Credit Position Bank Credit Terminology Types of Bank Loans Corporate and Foreign Borrowing Terminology Accounts Receivable Financing

6. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Sources of Short-Term Financing LT 8-2 There are various sources of short-term funds available to a firm: – Trade Credit from Suppliers – Bank Loans – Corporate Promissory Notes – Foreign Borrowing – Loans Against Receivables and Inventory

7. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Trade Credit LT 8-3 The largest source of short-term financing for a firm It is usually a 30-60 day grace period before a bill is due A cash discount is often given if payment is made within a specified time – Ex., 2/10 net 30 means a 2% discount is given if paid in 10 days; if not, the full amount is due in 30 days

8. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Net Credit Position LT 8-4 Net Credit Position: – a firm’s Accounts Receivable (A/R) minus its Accounts Payable (A/P) – if A/R is greater than A/P, it is a net provider of trade credit (positive number) – if A/P is greater than A/R, it is a net user of trade credit (negative number) – larger firms tend to be net providers of trade credit, while smaller firms are net users

9. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Bank Credit Terminology LT 8-5 Prime Rate: – the interest rate charged to a bank’s best customers – acts as a benchmark for calculating other interest rates Compensating Balance: – when a bank requires a minimum average account balance for business customers in order to qualify for a loan – can be thought of as a form of collateral Effective Interest Rate: – the actual interest rate or “true” cost of a loan – also known as the annual percentage rate (APR)

10. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Types of Bank Loans LT 8-6 Discounted Loan: – when a bank deducts the interest on the loan in advance and lends the balance Installment Loan: – calls for a series of equal payments over the life of the loan – ex., most car loans and home mortgages Compensating Balance Loan: – when a compensating balance is required as part of the loan

11. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Corporate and Foreign Borrowing Terminology LT 8-7 Commercial Paper: – a short-term unsecured promissory note issued to the public in minimum units of $25,000 – total amount of commercial paper outstanding has increased greatly in recent years Eurodollar: – a U.S. dollar held or deposited in a foreign bank – loans from foreign banks denominated in American dollars are called Eurodollar loans

12. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Accounts Receivable Financing LT 8-8 A/R financing includes 2 choices: – pledging accounts receivable as collateral for a loan OR – an outright sale (also called factoring) of receivables to a bank or finance company Tends to be a relatively expensive source of financing