Tài chính kế toán - Chapter 9: Short - Term debt

Chapter 9Short-term debtLearning objectivesOverview of the characteristics of various forms of short-term debtMain typesTrade credit, bank overdraft, commercial and bank-accepted bills, promissory notes, negotiable certificates of deposit, inventory accounts receivable and factoring SourcesReasons and patterns of useAdvantages and disadvantages for borrowers and lendersCalculations relevant to discount securitiesChapter organisation9.1 Trade credit9.2 Bank overdrafts9.3 Commercial bills9.4 Calculations: discount securities9.5 Promissory notes9.6 Negotiable certificates of deposit9.7 Inventory finance, accounts receivable, financing and factoring9.8 Summary9.1 Trade creditShort-term debt is a financing arrangement for a period of less than one year with various characteristics to suit borrowers’ particular needsTiming of repayment, risk, interest rate structures (variable or fixed) and the source of fundsMatching principleShort-term assets should be funded with short-term liabilitiesThe importance of this principle was highlighted by the GFC(cont.)9.1 Trade credit (cont.)A supplier provides goods or services to a purchaser with an arrangement for payment at a later dateOften includes a discount for early payment (e.g. 2/10, n/30, i.e. 2% discount if paid within 10 days, otherwise the full amount is due within 30 days)From provider’s perspectiveAdvantages include increased salesDisadvantages include costs of discount and increased discount period, increased total credit period and accounts receivable, increased collection and bad debt costs(cont.)9.1 Trade credit (cont.)The opportunity cost of the purchaser forgoing the discount on an invoice (1/7, n/30) is: Chapter organisation9.1 Trade credit9.2 Bank overdrafts9.3 Commercial bills9.4 Calculations: discount securities9.5 Promissory notes9.6 Negotiable certificates of deposit9.7 Inventory finance, accounts receivable, financing and factoring9.8 Summary9.2 Bank overdraftsMajor source of short-term financeAllows a firm to place its cheque (operating) account into deficit, to an agreed limitGenerally operated on a fully fluctuating basisLender also imposes an establishment fee, monthly account service fee and a fee on the unused overdraft limit(cont.)9.2 Bank overdrafts (cont.)Interest rates negotiated with bank at a margin above an indicator rate, reflecting the borrower’s credit riskFinancial performance and future cash flowsLength of mismatch between cash inflows and outflowsAdequacy of collateralIndicator rate typically a floating rate based on a published market rate, e.g. BBSWIn some countries overdraft borrower may be required to hold a credit average balance or compensating credit balanceChapter organisation9.1 Trade credit9.2 Bank overdrafts9.3 Commercial bills9.4 Calculations: discount securities9.5 Promissory notes9.6 Negotiable certificates of deposit9.7 Inventory finance, accounts receivable, financing and factoring9.8 Summary9.3 Commercial billsA bill of exchange is a discount security issued with a face value payable at a future dateA commercial bill is a bill of exchange issued to raise funds for general business purposesA bank-accepted bill is a bill that is issued by a corporation and incorporates the name of a bank as acceptor(cont.)9.3 Commercial Bills (cont.)(cont.)9.3 Commercial Bills (cont.)Features of commercial bills—parties involved (bank-accepted bill)(cont.)9.3 Commercial Bills (cont.)Features of commercial bills—parties involved (bank-accepted bill) (cont.)DrawerIssuer of the billSecondary liability for repayment of the bill (after the acceptor)AcceptorUndertakes to repay the face value to the holder of the bill at maturityAcceptor is usually a bank or merchant bank(cont.)9.3 Commercial Bills (cont.)Features of commercial bills—parties involved (bank-accepted bill) (cont.)PayeeThe specified party to whom the bill is to be paid, i.e. the party who receives the fundsUsually the drawer, but the drawer can specify some other party as payeeDiscounterThe party that discounts the face value and purchases the billThe provider or lender of the fundsMay also be the acceptor of the bill(cont.)9.3 Commercial Bills (cont.)Features of commercial bills—parties involved (bank-accepted bill) (cont.)EndorserThe party that was previously a holder of the billSigns the reverse side of the bill when selling, or discounting, the billOrder of liability for payment of the bill runs from acceptor to drawer and then to endorser(cont.)9.3 Commercial Bills (cont.)The flow of funds (bank-accepted bills)(cont.)9.3 Commercial Bills (cont.)The flow of funds (non-bank bills)Alternatively, a bill can be drawn by the bank and accepted by the borrowerThe bank is both drawer and discounter of the billIf the bank rediscounts a bill (sells to a third party), the bank becomes the endorser, creating a bank-endorsed billFunds are lent to borrower as payeeAt maturity date the borrower, as acceptor of the bill, is liable to pay face value to the holder of the bill(cont.)9.3 Commercial Bills (cont.)Establishing a bill financing facilityBorrower approaches bank or merchant bankAssessment made of borrower’s credit riskCredit rating of borrower affects size of discountMaturity usually 30, 60, 90, 120 or 180 daysMinimum face value usually $100 000(cont.)9.3 Commercial Bills (cont.)Advantages of commercial bill financingLower cost than other short-term borrowing forms, i.e. overdraft, fully-drawn advancesBorrowing cost (yield) determined at issue date (not affected by subsequent changes in interest rates)A bill lineArrangement with a bank where it agrees to discount bills progressively up to an agreed amountTerm of loan may be extended by ‘rollover’ at maturityChapter organisation9.1 Trade credit9.2 Bank overdrafts9.3 Commercial bills9.4 Calculations: discount securities9.5 Promissory notes9.6 Negotiable certificates of deposit9.7 Inventory finance, accounts receivable, financing and factoring9.8 Summary9.4 Calculations: discount securitiesCalculations consideredCalculating price—yield knownCalculating face value—issue price and yield knownCalculating yieldCalculating price—discount rate knownCalculating discount rate(cont.)Calculating price—yield known(cont.)Calculating price—yield known (cont.)Example 3: A company decides to fund its short-term inventory needs by issuing a 30-day bank-accepted bill with a face value of $500 000. Having approached two prospective discounters, the company has been quoted yields of 9.52% per annum and 9.48% per annum. Which quote should the company accept, and what amount will the company raise?(cont.)Calculating price—yield known (cont.)An alternative formula for calculating priceCalculating face value—issue price and yield known(cont.)Calculating face value—issue price and yield known (cont.)Example 4: A company needs to raise additional funding of $500 000 to purchase inventory. The company has decided to raise the funds through the issue of a 60-day bank-accepted bill rollover facility. The bank has agreed to discount the bill at a yield of 8.75%. At what face value will the initial bill be drawn?Calculating yield(cont.)Calculating yield (cont.)Example 7: In Example 3, a company issued a 30-day bank-accepted bill with a face value of $500 000. The bill was discounted at a yield of 9.48% per annum, representing a price of $496 134.23. After seven days the discounter sells the bill in the short-term money market for $497 057.36. The bill is not traded again in the market. Calculate the yield to the original discounter and to the holder at maturity.(cont.)Calculating yield (cont.)Yield to original discounter: Yield to holder at maturity:Calculating price—discount rate known(cont.)Calculating price—discount rate known (cont.)Example 8: The price of a 180-day bill, with a face value of $100 000, selling at a discount of 14.75%, would be:The discount in this formula is effectively the rate of return to the buyer of the bill (or the cost of funds to the drawer of the bill), expressed as a percentage per annum, in relation to the face value of the bill.Calculating discount rate(cont.)Calculating discount rate (cont.)Example 9: A 180-day bill with a face value of $100 000 and selling currently at $92 000, with a full 180 days to run to maturity, has a discount rate of:Chapter organisation9.1 Trade credit9.2 Bank overdrafts9.3 Commercial bills9.4 Calculations: discount securities9.5 Promissory notes9.6 Negotiable certificates of deposit9.7 Inventory finance, accounts receivable, financing and factoring9.8 Summary9.5 Promissory notesAlso called P-notes or commercial paper, they are discount securities, issued in the money market with a face value payable at maturity but sold today by the issuer for less than face value Typically available to companies with an excellent credit reputation because:there is no acceptor or endorserthey are unsecured instruments(cont.)9.5 Promissory notes (cont.)Calculations—use discount securities formulaeIssue programsUsually arranged by major commercial banks and money market corporationsStandardised documentationRevolving facilityMost P-notes are issued for 90 daysBy tender, tap issuance or dealer bids(cont.)9.5 Promissory notes (cont.)Underwritten issuesUnderwriting guarantees the full issue of notes is purchased and typical fee is 0.1% per annumUnderwriter is usually a commercial bank, investment bank or merchant bankThe underwritten issue can incorporate a rollover facility, effectively extending the borrower’s line of credit beyond the short-term life of the P-note issueIssues may also be non-underwrittenIssuer may approach money market directlyCommercial bank, investment bank or merchant bank may be retained as lead manager and receive feesChapter organisation9.1 Trade credit9.2 Bank overdrafts9.3 Commercial bills9.4 Calculations: discount securities9.5 Promissory notes9.6 Negotiable certificates of deposit9.7 Inventory finance, accounts receivable, financing and factoring9.8 Summary9.6 Negotiable certificates of depositShort-term discount security issued by banks to manage their liabilities and liquidityMaturities range up to 180 daysIssued to institutional investors in the wholesale money marketThe short-term money market has an active secondary market in CDsCalculations—use discount securities formulaeChapter organisation9.1 Trade credit9.2 Bank overdrafts9.3 Commercial bills9.4 Calculations: discount securities9.5 Promissory notes9.6 Negotiable certificates of deposit9.7 Inventory finance, accounts receivable, financing and factoring9.8 Summary9.7 Inventory finance, accounts receivable financing and factoringInventory financeMost common form is ‘floor plan finance’Particularly designed for the needs of motor vehicle dealers to finance their inventory of vehiclesBailment common—finance company holds title to dealership’s stockDealer is expected to promote financier’s financial products(cont.)9.7 Inventory finance, accounts receivable financing and factoring (cont.)Accounts receivable financingA loan to a business secured against its accounts receivable (debtors)Mainly supplied by finance companiesLending company takes charge of a company’s accounts receivable; however, the borrowing company is still responsible for the debtor book and bad debts(cont.)9.7 Inventory finance, accounts receivable financing and factoring (cont.)FactoringCompany sells its accounts receivable to a factoring company Converting a future cash flow (receivables) into a current cash flowFactoring provides immediate cash to the vendor; plus it removes administration costs of accounts receivableMain providers of factor finance are the finance companiesFactor is responsible for collection of receivables(cont.)9.7 Inventory finance, accounts receivable financing and factoring (cont.)Factoring (cont.)Notification basis: vendor is required to notify its (accounts receivables) customers that payment is to be made to the factorRecourse arrangementFactor has a claim against the vendor if a receivable is not paidNon-recourse arrangementFactor has no claim against vendor companyChapter organisation9.1 Trade credit9.2 Bank overdrafts9.3 Commercial bills9.4 Calculations: discount securities9.5 Promissory notes9.6 Negotiable certificates of deposit9.7 Inventory finance, accounts receivable, financing and factoring9.8 Summary9.8 SummaryShort-term debt is appropriate for funding short-term assets (matching principle)Trade credit—simple and commonBank overdraft—commonDiscount securitiesBill financing—important source of fundsPromissory notes (P-notes)—good credit rating requiredCertificates of deposit (CDs)—issued by banks to manage liabilities and liquidityInventory loans, accounts receivable finance and factoring—alternative sources of finance for small and medium-sized businesses (SMEs)