Working Capital: Short-Term Liabilities

1
Working Capital Short-Term Liabilities
2
Sources of Short Term Funds

• Trade Credit
• Bank Borrowing (Prime Rate)
• Commercial Paper (Direct or Dealer Placed)
• Accounts Receivable Financing (Factoring)
• Inventory Financing

3
Bank Credit Terminology

• Prime Rate
• the interest rate charged to a banks better
  customers (large strong companies dont borrow
  from a bank)
• acts as a benchmark for calculating other
  interest rates
• note that the prime rate is related to but not
  the same as the fed funds rate, EURIBOR, or
  LIBOR.
• 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
• adjusts the APR for compounding
• LIBOR (London Interbank Offered Rate)
• rate that most international banks charge one
  another for dollar-denominated loans in the
  London market. Euro bond market is unregulated.

4
Example Rates

• Some sites for rate information
• http//www.forecasts.org/interest-rate/fed-funds-i
  nterest-rate.htm
• http//www.bankrate.com/brm/ratehm.asp

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Turning Short-Term Interest Rates Into Annual
Rates

• Effective Annual Rate
• Short-Term Rate X Days
  in the year
• Days loan is outstanding
• Example Borrow 10,000
• Interest 800
• Period 150 days
• Effective
• Annual 800 X 360
  19.2
• Rate 10,000 150

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Cost of Trade Credit

• Implicit cost of trade credit
• Discount X
  360
• 100 - Discount Final Due Date -
  Discount Period

7
Cost of Trade Credit Example

• Terms 2/10 net 30
• Actual pay in 45 days
• For every 100 of payment
• 2 2.04
• 98
• Pay in 30 days
• 2 X 360 36.73
• 98 20
• Pay in 45 days
• 2 X 360 20.99
• 98 35

8
Cost of Installment Loan

• Effective rate
• on installment 2 X Annual no. of payments
  X Interest
• loan (Total no. of
  payments 1) X Principal
• Grants
• Approximate Interest
• rate Average Amount
  of Loan
• Salesmens Interest
• stated rate Amount of
  Loan

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Cost of Installment Loan Example

• Borrow 10,000
• Interest 1,000
• Payments 12 payments of 916.67
• Salesmens 1,000 10
• stated rate 10,000
• Grants
• Approximate 1,000 20
• rate 5,000
• Effective 2 X 12 X 1,000 18.5
• rate 13 X 10,000

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Cost of a Discount Loan

• Effective Interest
• rate Principal - Interest
• Example
• Borrow 10,000
• Interest 10
• Effective rate 1,000
  11.11
• 10,000 - 1,000

11
Cost of Loan with Compensating Balance

• Effective Interest rate
• rate (1- c)
• where c compensating balance expressed as
  a decimal
• Example
• Borrow 10,000
• Interest 10
• Compensating balance 20
• Effective 10
  12.5
• rate 1 - .2
• Effective 1,000
  12.5
• rate 10,000 - 2,000

or
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Movement of Prime Rate and the London Interbank
Offer Rate on U.S. Dollar Deposits
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Commercial Paper Characteristics

• Short-term (3 months is common)
• Unsecured IOU from large prestigious firms
• 25,000 minimum
• Finance paper or direct paper (i.e.,GMAC)
• Dealer paper (Industrial Companies)
• Interest is below prime
• Low default risk
• Good marketability

14
Comparison of Commercial Paper Rate to Prime Rate
15
Total Commercial Paper Outstanding
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Accounts Receivable Financing

• Pledging Accounts Receivable
• Factoring Receivables
• Asset-Backed Public Offerings

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Inventory Financing

• Stages of Production
• Raw Materials
• Work-In-Process
• Finished Goods
• Nature of Lender Control
• Blanket Liens
• Trust Receipts
• Warehousing (Bonding)