Interim

Financing
LEARNING OBJECTIVES
The need for short-term financing.
The advantages and disadvantages of short-
term financing.
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
 WHY DO FIRMS NEED
INTERIM FINANCING?
 Cash flow from operations may not be sufficient
to keep up with growth-related financing needs.
 Firms may prefer to borrow now for their
inventory or other short term asset needs rather
than wait until they have saved enough. Firms
 prefer short-term financing instead of long- term
sources of financing due to:
• easier availability
• usually has lower cost (remember yield curve)
• matches need for short term assets, like inventory
 SOURCES OF INTERIM
FINANCING
Short-term Loans.
• borrowing from banks and other financial
institutions for one year or less.
Trade Credit.
• borrowing from suppliers
Commercial Paper.
• only available to large credit- worthy
businesses .
TYPES OF INTERIM LOAN
• A legal IOU that spells out the terms of the
loan agreement, usually the loan amount, the
term of the loan and the interest rate.
• Often requires that loan be repaid in full with
interest at the end of the loan period.
• Usually with a Bank or Financial
Institution; occasionally with suppliers or
equipment manufacturers
 TYPES OF INTERIM LOAN
Line of Credit
• The borrowing limit that a bank sets for a firm
after reviewing the cash budget.
• The firm can borrow up to that amount of
money without asking, since it is pre-approved
• Usually informal agreement and may change
over time
• Usually covers peak demand times, growth
spurts,etc.
 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.
 ESTIMATION OF COST OF
INTERIM CREDIT
Calculation is easiest if the loan is for a one year
period:
Effective Interest Rate is used to determine the cost of
the credit to be able to compare differing terms.
Effective Cost (interest + fees)
=
Interest Rate Amount you get to use
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%
VARIATION IN INTERIM TERM
 lenders require that a minimum amount, called a
compensating balance be kept in your bank
account. It is taken from the amount you want to
borrow.
If your compensating balance requirement is
$500, then the amount you can use is reduced by
that amount.
Effective Rate (APR) for a $10,000 simple interest
10% loan with a $500 compensating balance =
$1,000/($10,000-$500) = .1053 = 10.53%.
BOTH DISCOUNT INTEREST AND
COMPENSATING BALANCE
Sometimes, lenders will require both discount
interest (paid in advance) and a compensating
balance.
If the interest is $1,000 and the compensating
balance is $500, then the effective rate (APR)
becomes:
$1,000 / $10,000 - $1,000 - $500
$1,000 / $8,500 = 11.76%
COST OF INTERIM CREDIT
• Typically receive a discount if you pay early.
• Stated as: 2/10, net 60
Purchaser receives a 2% discount if
payment is made within 10 days of the
invoice date, otherwise payment is due
within 60 days of the invoice date.
• The cost is in the form of the lost discount if
you don’t take it.
 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
 COST OF COMMERCIAL PAPER
$1 million issue of 90 day commercial paper quoted at 4%
discount rate.
Step 1: Calculate D = .04 x $1 mill. x 90 = $10,000
360

 Step 2: Calculate price (amount you get)

= $1,000,000 - $10,000
= $990,000

 Step 3: Calculate effective rate (APR)

= $10,000 / $990,000 = 1.010% x 4 = 4.04%
 AMOUNT RECIEVABLE AS COLATERAL
Promise that the borrowing firm will pay the
lender any payments received from the accounts
receivable colateral in the event of default.
Since accounts receivable fluctuate over time, the
lender may require certain safeguards to ensure that
the value of the collateral does not go below the
balance of the loan.
So, normally a bank will only loan you 70 -75% of the
receivable amount
Accounts receivable can also be sold outright. This is
known as factoring.
 COST OF BORROWING AGAINST
RECEIVABLE
Average monthly sales = $100,000
60 day terms, so average Acct Rec balance = $200,000
Bank loans 70% of Accts Rec = $140,000
Interest is 3% over prime (say 8%) = 11% x $140,000 =
$15,400
1% fee on all receivables = 1% x $100,000 x 12 =
$12,000
APR = $15,400 + $12,000 x 1/1 = 19.57%!
$140,000
 INVENTORY AS COLATERAL
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 won’t get
much
HOME LOAN AGENCIES/ BANKS AND
THEIR INTEREST RATE
S. No. BANK INTEREST RATES PROCESSING FEES

1 Rs.2,000 –
State Bank of India 7.90% - 8.55% p.a.
Rs.10,000
2
HDFC Ltd. 8% - 8.30% p.a Up to 0.50%

3
ICICI Bank 8.60% - 9.40% p.a. 0.50% to 1%

4
Axis Bank 8.55% - 9.40% p.a Up to 1%

5
Bank of Baroda 8.15% - 9.15% p.a. 0.25% to 0.50%

6 PNB Housing Up to 0.25% (max.

8.95%- 9.95% p.a.
Finance Ltd. Rs. 15,000) + GST
7 LIC Housing Finance Rs. 10,000-
8.40% - 8.50% p.a. Rs.15,000
Limited (+Service Tax)
S. No. BANK INTEREST RATES PROCESSING FEES

8 United Bank of
8.00%- 8.15% p.a. Rs.1000/ or Above
India
9 0.50 % or Max Rs.
Vijaya Bank 8.10% - 9.10% p.a.
20,000/-
10
UCO Bank 8.05% to 8.60% p.a. 0.50%

11 0.50% of the Loan

Oriental Bank 8.25% - 8.80% p.a.
Amount
12 Kotak Mahindra
8.60% - 9.40% p.a. up to Rs.10,000
Bank
13 0.50%
Canara Bank 8.05% - 10.05% p.a.
(Max. Rs.10,000)
14 0.25%
Bank of India 8.10% - 8.40% p.a.
(Max. Rs.20,000)
S. No. BANK INTEREST RATES PROCESSING FEES

15
IDBI Bank 8.25% - 8.80% p.a. 0.50%

16 Indian Overseas
Bank 8.20% - 10.95% p.a. 0.50%

17 0.50%
South Indian Bank 9.00% p.a. onwards
(Max. Rs.10,000)
18 Central Bank of 1%
8.00% - 8.55% p.a.
India (or Min. Rs.10,000)
19
Tata Capital 9.25% p.a. 2%

20
Yes Bank 9.78% - 10.68% p.a. Up to 2%

21 Jammu and
Kashmir Bank 8.65% - 8.95% p.a. 2% - 3%
PERMANENT
FINANCING
 WHAT IS PERMANENT FINANCING?
• It refers to longer term loan or debt instrument, longer term e
quity financing.
• Utilized to buy or develop the kind of long lasting fixed assets l
ike machinery and factories.
• Payoff and contribution from such assets happen over larger s
pan of time.
• mostly preferred as the risk of principle won’t be paid is turne
d down.
 HOW IT WORKS ?
• With longer term debt fina
ncing, money is borrowed
from third party source so
that business can finance a
particular project.
• It centers on putting up co
mpany assets in exchange
for obtaining funding for p
articular projects.
DISTINCTION BETWEEN SHORT TERM FINANCIN
G AND PERMANENT FINANCING.
SHORT TERM FINANCING PERMANENT FINANCING
1.Requires the debt to be paid back in 1.Hence, it claims the opposite idea i.e.
12 months. more than 12 months.
2.It involves loans of shorter duration. 2.Long term debts types: Bonds,
Mortgages, and Loans.
3.It is repaid in single lump sum 3.These payments are done annually,
repayment. monthly, or in few periodic lump sum
repayment.
4.It has purpose of financing daily 4.It is specifically used for buying assets
operations. that require few or many years to
For Example: firms that operate in payback
seasonal industry and capacity for For example: if a small industry wants
buying the raw materials and products to expand , permanent financing would
and hence paying off from the allow to raise their revenues resulting
revenues. profits created by higher production
output of long term industry.
THANK YOU