Flashcards in Working Capital Management Module Deck (89):
_____ term financing is debt that matures within one year and is normally used to meet seasonal and current asset requirements.
This is because the debt matures within 12 months.
Secured short-term financing differs from unsecured short-term financing in that the former has particular ______ pledged as collateral.
________ is required for secured short-term financing, where the creditor believes that the debtor may default on the payments.
___________ financing is generated from the usual operations of a company and are made up of accounts payable and accruals.
Spontaneous because it is unplanned and just a consequence of doing business. Accruals because liabilities arise for these services but payment has not yet been made, for example wages and taxes.
Accounts payable are an important source of ________ short-term financing for companies.
It is unsecured because there is no collateral required.
When a Supplier supplies goods to a Purchaser and payment is not required on or before delivery but instead extended on trade credit, then this type of short-term financing appears on the balance sheet as current ___________.
Current because the financing is for less than 12 months
Where payment for goods is ________, the Purchaser agrees to the sale of goods subject to the Supplier's credit terms.
The Supplier lays out the terms for payment where payment is not due on or before delivery of the goods.
The Supplier's credit terms usually include a cash ________, which indicates a percentage reduction from the sale price if the buyer pays within a specified timeframe shorter than the credit period.
The credit period is the maximum number of days in which the Purchaser must make full payment. In order to provide the Purchaser with an __________ to pay earlier, a discount is offered if payment is made within a shorter term period - this is called the Cash Discount Period
The beginning of the credit period is normally the invoice date or the EOM (____________), which refers to the credit period beginning at the start of the next month.
end of month
The invoice date is normally the beginning of the credit period. Where the EOM is referred to, the start of the following month is the beginning of the _______ period.
The shorthand credit term "4/15 net 45 EOM", means that the length of the credit period is ___ days, with the cash discount being 4% lasting for 15 days, with the credit period beginning at the end of the month.
This is the recognized method of decrypting shorthand credit terms.
Suppliers can afford to offer credit terms to their Purchasers because they have already accounted for this cost in the ________ price.
It does not make sense to offer credit for free, so Suppliers build it into the price charged to their Customers.
If a Purchaser wishes to take up the cash discount offered by the Supplier, then ideally the invoice should be settled on the ____ day of the discount period.
There is no benefit in paying it any sooner.
In order to remain competitive, most Suppliers within their own industry tend to offer _______ credit terms.
To compete for business, this is a wise strategy or else Purchasers may choose to buy from another supplier that offers better terms.
The cost of giving up a cash discount is the ______ interest paid in order to delay the account payable for an extra number of days.
In other words, the cost is the amount of discount given up in delaying payment for the additional period of days
Where CD=cash discount percent, N=number of days payment can be delayed by giving up the cash discount and assuming that there are 360 days per annum, then the calculation for the cost of giving up the discount is _____________
CD/100%-CD x 360/N
A simpler formula for estimating the cost of giving up the cash discount is = CD x ______
__________ accounts payable' means delaying payment beyond the number of days given for payment.
Payment is delayed and hence the accounts payable is 'stretched'.
The effect of stretching accounts payable is to reduce the cost of giving up the ____ discount.
By delaying payment a company is reducing the implicit cost of giving up the cash discount.
Delaying payment of wages to employees is an example of manipulating an _______ in order to generate source of spontaneous short-term financing.
By delaying payment of wages, a company is effectively taking a ____ against the employees wages. For example ABC Company's payroll is $100,000 a week. By delaying wage payment by 1 week every week, the company is actually borrowing $100,000 for a year from the employees. If the company can earn 10% on that investment, then this strategy can save them $10,000 ($100,000 x 10%) per year.
The main source of unsecured loans to business are _____.
This is one of the core operations and functions of a bank.
A short-term unsecured self liquidating loan is one made against the liquidation of __________ or the sale of goods.
As inventory and receivables are liquidated to cash, the funds needed to pay off the ____ are generated. An example of such a loan is one to a farmer against the sale of crops. It is usually meant to see a company through seasonal adjustments.
What are the three ways unsecured funds are lent by banks?
1) Single payment notes
2) Lines of credit
3) Revolving credit arrangements
Revolving credit is one of the types of unsecured lending offered by banks and is a __________ line of credit
When a bank makes a loan to a company, the rate of interest charged is usually determined by the _____ rate of interest.
The prime rate of interest is the ______ rate of interest charged to the best customers of the country's major banks. This rate will fluctuate depending on supply and demand for short-term funding.
A _______ is added to the prime rate when banks lend unsecured funds to customers that are assessed to be riskier than the most reliable customer.
The premium is added to cover the risk the bank is taking in lending unsecured funds to a borrower. However, unsecured funds are generally not loaned to customers whom the bank feels are too much of a risk.
A _____ rate of interest is one where the rate is set at a determined level above the prime rate at the start of the loan and is fixed for the duration of the loan term.
The rate is set at the start of the loan and fixed till maturity - this is the definition of a fixed loan.
A ________ rate loan is one where the rate is set at a determined level above the prime rate at the start of the loan but is allowed to fluctuate above the prime rate as the prime rate varies until the term of the loan expires.
This is the definition of a floating-rate loan.
The lender bears a lower ____ on a floating-rate loan than a fixed-rate loan.
The floating-rate loan is less risky because it fluctuates according to the change in prime rate, whereas the fixed rate is fixed even if the prime rate goes up.
The effective rate of interest is the actual ________ rate of interest, rather than the stated rate of interest.
It is "effective" because this is the actual rate you will be paying each year.
In order to calculate the effective interest rate, the finance charges, usable funds and term of the loan in ____ must be factored into the calculation.
Usable funds is the amount of the loan principal actually received by the _________.
Where FC=finance charges, N=term of loan (assumes 360 day year), UF-usable funds; the calculation for the effective rate of interest is = __/UF x 360/N.
FC = Finance charges
___________ is the formula for calculating the effective rate of interest.
FC/UF x 360/N
A) FC = Finance charges
B) N=term of loan (assumes 360 day year)
C) UF-usable funds
A loan where the interest is paid in advance from the amount borrowed is called a _______ loan.
In order to calculate the _______ funds for a discount loan, interest must be deducted from the amount borrowed.
The interest is deducted from the sum borrowed before handing the sum over to the borrower.
Discount loans have a ______ effective rate of interest than loans where the interest is paid upon maturity of the loan.
The effective rate is higher because the interest is paid upfront from the sum borrowed and hence the usable funds received are lower, which in turn lifts the rate of interest, when compared to a normal loan.
A ______ payment note is a one-time loan payable on maturity as a single amount, which may have a fixed or floating rate of interest.
A ____ of credit is an agreement drawn up between a commercial bank and a business over the amount of short-term unsecured borrowing that the bank will make available to the business over a particular period.
This is the definition of a line of credit. It is not a guarantee by the bank to loan the business an amount of money, it is a possibility if the bank has the funds to do so.
The amount of a line of credit is the ________ that the business can borrow.
Before approving a business a line of credit, what documents would the bank normally want to examine?
Their cash budget, pro forma income statement, pro forma balance sheet and recent financial statements.
This would allow the bank to assess the risk it is taking in deciding whether to offer the borrower a line of credit.
The interest rate charged on a line of credit is normally the ________ rate.
The floating rate is less risky for banks than the fixed rate as this rate varies with the prime rate. Furthermore, there is an opportunity to charge more because in a line of credit, should the rate go up, then the new ______ higher interest rate is charged retrospectively on the entire loan amount.
When offering a line of credit agreement to a borrower, the bank may make that agreement subject to _________ change restrictions, which means that should any major changes in the borrower's financial conditions or operations, then the bank has the right to revoke the agreement.
Any major change in financial operations or conditions may adversely impact the borrower's ability to repay the loan and hence the condition.
Many banks offering short-term unsecured loans will insist that the borrower retain a ____________ balance in a checking account equal to 10-20% of the amount borrowed.
This forces the borrower to be a good bank customer and is a good earner for the bank.
Many banks usually require an annual ________ from their borrowers, which involves having a zero balance for a certain number of days every year.
This is to ensure that the short-term loan does not morph into a long-term one.
A guaranteed line of credit made available to a borrower by a bank for a specified period of time is known as a _________ credit agreement.
This is the definition of a revolving line of credit and basically means that it is always available to the borrower even if money is scarce.
The __________ fee is the extra fee charged on a revolving credit agreement.
The __________ fee is an extra charge (on top of the interest rate charged on the loan amount), usually amounting to 5%, that is exacted on the amount of unused balance in the credit line.
Well-known firms with an excellent credit standing can issue a form of short-term, unsecured financing known as __________ paper, which is sold at a discount from it's par value.
For example Famous Corp issues $1m commercial paper, 90 day maturity period, selling for $990,000. At the end of the 90 days, the purchaser will receive $1m for a $990,000 investment.
Even though the cost of borrowing through commercial paper is _______ than borrowing from a bank, many firms still choose the latter option because of high fees associated with issuing commercial paper and to ensure a good working relationship with their bank.
High fees because of fees paid to dealers of commercial paper, third-party ratings and other administrative charges.
It is important to have a good relationship with the bank, so __________ from them may be a good way of developing the relationship further.
The critical difference between international and domestic transactions is that the former is normally received in a foreign ________.
As the transaction is international, the currency used is normally that of the _____ country where the transaction took place.
One of the main risks of engaging in international transactions is _________ in currency.
An _____ with foreign currency denominated accounts payable will suffer a loss if the dollar depreciates. Conversely, an exporter will suffer a loss if the dollar appreciates relative to the foreign currency.
A _____ of credit is a letter written by the company's bank, addressed to the company's foreign supplier, guaranteeing payment of an invoiced amount if all stated conditions are met.
This is the definition of a letter of credit. It has evolved to make international financial transactions easier to execute.
In international trade between corporate subsidiaries, the practice of "______" refers to paying each other only the net amounts due.
This cuts down on costs and charges.
Companies tend to turn to secured sources of funding once the ________ sources are exhausted.
If a company is unable to get an unsecured loan, then the only other option available is an ________ loan.
Holding collateral does not actually lessen the risk of the loan because although it reduces the possible loss to the bank, it does not actually reduce the risk of ______ itself.
Possessing collateral is not in itself going to reduce the risk of default. It is just there to reduce the risk of loss, so that the collateral can be readily liquidated to _____ the costs to the bank in the event of default.
Current assets such as account receivable and inventory are the most desirable forms of _______ because they are very liquid.
These assets are highly liquid and are intended to be on the books for less than 12 months.
The lender usually determines the ideal ________ advance to make against the collateral.
The percentage of the ____ value of the collateral that is made up of the principal of the secured loan.
In terms of the cost of borrowing, _______ loans are more expensive.
Secured loans are more expensive because there are increased administration costs involved with regards to the collateral and also a higher risk of ________ by the borrower (these borrowers cannot get unsecured loans because their credit rating is not very good).
Banks and __________ finance companies offer secured short-term financing.
Commercial Finance Companies only make secured loans to __________. They offer higher rates of interest because their borrowers do not qualify for bank loans as their credit rating is not very good.
The two common ways of obtaining short-term secured financing with accounts receivable is by ________ and factoring accounts receivable.
These are the 2 common ways of using accounts receivable as collateral for a secured short-term loan.
What are two common ways of obtaining short-term secured financing with accounts receivable?
Pledging and Factoring
Pledging accounts receivable indicates the use of those accounts as collateral to get a short-term loan, whereas factoring accounts receivable means _______ those accounts at a discount to the financial institution to obtain funds.
In _________ accounts receivable, the accounts are only used as collateral and ownership vests with the borrower. In factoring receivables, the accounts are actually sold to the financial institution and so ownership vests with the financial institution.
Where accounts receivable are pledged, the lender registers his interest in the collateral by registering a ____.
A lien is a publicly disclosed legal ____ on the collateral.
Pledges of accounts are normally made on a _______________ basis, whereas factoring accounts receivable is normally made on a notification basis.
For pledges, there is normally no necessity to inform the customer about the collateral arrangement and payment is usually made as normal to the borrower. However, in factoring, payments are usually made directly to the _______ (usually a financial institution), where the customer knows full well of the factoring arrangement.
Sales of the accounts receivable to the factor are made on a ___________ basis, which means that the factor accepts all credit risks on the accounts sold.
Since they own those accounts, they also absorb the risk of non-payment or default by the customers.
Despite the higher costs, the advantage of factoring include having a consistent pattern of cash flows and elimination of the credit and __________ departments.
__________ are regular because the factor deposits money as the account is paid or on the last day of the credit period, whichever occurs first, regardless of whether the customer has actually paid or not. Collection and cash departments are not needed as the factor is managing these services.
_________ is attractive as collateral because it's market value is usually higher than the book value.
The book value of inventory is calculated by taking cost and subtracting accumulated ______________ from it. Therefore, it is usually less than the price that inventory can be sold for on the open market.
A floating inventory lien is one where the lender has a legal claim over the borrower's general inventory as ________.
This type of arrangement is used where the borrower has a diversified inventory consisting of mainly inexpensive items.
A _____ receipt inventory loan is one whereby money is advanced against specific items of usually high-value inventory, in exchange for the borrower's promise to repay the loan immediately, with interest, on the sale of those items.
This is the definition of a trust receipt inventory loan; where effectively the borrower is trusted to repay the loan on sale of the specific items.