F9 Lecture

COMM2001 Financial Management Tony Stanger
Chapter 15 Current liabilities management
Gitman, Juchau & Flanagan: Principles of Managerial Finance 4e 2005 Pearson Education Australia
Learning Objectives
discuss the firms credit terms see the effect of stretching accounts payable describe unsecured types of short term credit describe secured types of short term credit explain how to use inventory as collateral
Spontaneous liabilities
Spontaneous liabilities are types of funding that arise from the normal operations of the firm two main types - accounts payable - accruals advantages - unsecured short term financing (no pledging of specific assets as collateral involved) - interest-free financing (no borrowing involved)
Accounts payable management involves maximising the time between purchase of supplies and mailing payment to the supplier (without damaging credit rating) eg. if the terms are net 30, the account should be paid 30 days from the beginning of the credit period result: stretching accounts payable allows maximum use of interest-free loan
Analysing credit terms involves choosing whether to pay invoices early or late eg. if the firm is offered credit terms for N days that include a cash discount (CD), it has two options: to take the cash discount or forgo it result depends on cost of forgoing cash discount = CD/(100%-CD) x 365/N
Accruals are liabilities for services received for which payment has yet to be made examples: wages, taxes eg. delay payment of wages delay payment of taxes result: interest free loan from workers, government
Unsecured sources of short term loans

Unsecured types of financing involve no collateral being pledged by the borrower bank loans are a common form - typically in the form of an overdraft - can be used by small firms and big firms - provides funding for seasonal peaks

Bank loan interest rates prime rate = lowest rate charged by banks to their best customers fixed rate loan = loan with constant rate until maturity (set at a fixed margin above the prime rate) floating rate loan = loan with variable rate (set at a flexible margin above the prime rate)

Bank loan interest rate calculation nominal rate of interest - equals the contract rate - reflects the borrowers credit standing effective rate = (interest) / (amount borrowed) if interest is paid at maturity discount loan rate = (interest) / (amount borrowed - interest)

Bank loan terminology overdraft - a short term self liquidating loan subject to a pre-determined limit - operates by allowing the borrowers cheque account to go into deficit - may involve an interest charge on the unused portion of the overdraft
10

Bank loan terminology operating change restrictions are contractual regulations the bank imposes on the borrower eg - regular financial statements - notification of major business changes compensating balances is an amount the bank may require the firm to maintain in its cheque account annual clean-ups require the borrower to keep a zero overdraft balance for N days per year
11

Bill and note finance a bill of exchange is a written, unconditional order involving three parties for a specified sum to be paid on a specified date the drawer is the issuing party (= borrower) the acceptor agrees to pay ( = bank) the endorser purchases the bill (= lender)
12

Bill and note finance bank-accepted bills of exchange are bills that have been accepted by a bank implications:
the bank gaurantees the credit risk the bill trades as a low-risk security the bill trades at a low yield the bill is highly liquid
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Bill and note finance
14

Bill and note finance commercial bills of exchange are bills not accepted or endorsed by a bank promissory notes are short term unsecured commercial loan instruments
note: CBs need to be endorsed when transferred PNs are transferable without endorsement
15

Bill and note finance interest calculation interest is determined by the size of the discount (D) and length to maturity (N days) Example: Bertram Ltd issues $1m worth of P-notes with 90-day maturity at price (P) of $98,000 Solution: the 90-day interest rate is 2.04% (= $20,000/$980,000) and the effective annual interest rate is 8.41% = [(1+0.0204)4 -1]
16

International loans are frequently associated with international trade transactions a common form is a letter of credit = a letter written by a companys bank to a foreign supplier of goods stating that the bank guarantees payment of a foreign currency invoice amount netting : offshore transactions between subsidiaries creates the opportunity to minimise FX transactions costs
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Secured sources of short term loans

Secured types of financing involve collateral being pledged by the borrower a security agreement specifies the collateral held against the loan, including: - nature of asset - conditions of release - rights of claim agreements are registered with ASIC
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Ordinary collateral lenders try to match collateral duration to loan length a percentage advance is a % of the assets book value that constitutes the principal a service charge will be payable for the lenders administration expenses
19

Accounts receivable as collateral a pledge of accounts receivable involves using the firms accounts as security to obtain a loan the pledging process involves scrutiny by the lender of the quality and value of the accounts pledges can be on a notification or non-notification basis, depending on whether the account customer is informed their account is being used as collateral
20

Factoring accounts receivable involves the outright sale of accounts receivable at a discount to a bank (called the factor) in exchange for credit Invoice discounting is the sale of accounts receivable to a discounter, where the accounting function is retained by the firm
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Factoring and invoicing discounting agreements a lender selects accounts for purchase based on acceptable credit risk usually on a non-recourse basis, which is an understanding that the factor accepts all credit risks
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Using inventory as short term collateral seen as second to accounts receivable as collateral advantage: inventory has greater market value than its book value a floating charge over inventory is a lenders claim on the borrowers inventory
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Tutorial Week 13
Review Questions
15-1, 15-2, 15-3, 15-5 & 15-2
Problems
15-3, 15-7, 15-12* & 15-16 *
* The solution to these problems will be available on

WebCT.
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COMM2001 Financial Management Tony Stanger

Chapter 15 Current liabilities management

Unsecured sources of short term loans

Unsecured sources of short term loans

Unsecured sources of short term loans

Unsecured sources of short term loans

Unsecured sources of short term loans

Unsecured sources of short term loans

Unsecured sources of short term loans

Unsecured sources of short term loans

Unsecured sources of short term loans

Unsecured sources of short term loans

Unsecured sources of short term loans

Secured sources of short term loans

Secured sources of short term loans

Secured sources of short term loans

Secured sources of short term loans

Secured sources of short term loans

Secured sources of short term loans

* The solution to these problems will be available on

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