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05 SHORT-TERM
FINANCING

SHORT-TERM FINANCING Financing costs depends on the source of

The financing of a business from short-term financing. It usually includes interest
sources for a period of one year or less and payments, origination fees paid by borrower,
it assists the company in generating cash amortization of discount, etc.
for working capital and operating expenses
which are typically for a smaller amount. Net proceeds depends if the loan is
discounted or with compensating balance
Generating cash through online loans, requirement.
lines of credit, and invoice financing.
CLASSIFICATIONS OF SHORT-TERM FINANCING
COST OF SHORT-TERM FINANCING 1. SECURED SOURCES S-UNS
INTEREST Requires collateral
Financing cost from borrowed funds Receivable Financing
Inventory Financing
INTEREST RATE 2. UNSECURED
Indicate this cost or return as a Requires NO collateral
percentage of the amount you are Trade credit or spontaneous sources
borrowing. of financing
Commercial bank loan
TYPES OF INTEREST RATE N-E-R Revolving Credit Agreement vs.
1. NOMINAL INTEREST RATE Credit Line
Basis of cash payments on borrowings Cost of Installment Loans
A.K.A. Stated Rate Commercial paper

2. EFFECTIVE INTEREST RATE UNSECURED SOURCES T-B-P

Basis of determining the interest expense 1. Trade Credit /Spontaneous Sources of
on borrowings Financing
AK.A. Discount Rate Financing that arises from the normal
course of business
3. REAL INTEREST RATE
Takes inflation into account unlike TRADE CREDIT
nominal rate
Trade Credit =
NOMINAL INTEREST RATE
%D 360 or 365 days
x
Nominal Interest Rate 100% - % D CP- % D
= (Interest/Principal) x Time
Where:
EFFECTIVE INTEREST RATE % D = Percentage Discount
Effective Interest Rate CP = Credit Period
= (Financing Cost/Net Proceeds) x
2. Commercial Bank Loans
(365/Credit Period)
Banks are major source of unsecured
REAL INTEREST RATE short-term loans to businesses.

Real Interest Rate P

= Nominal Rate - Inflation Factor
R T
ACT1124 | FInancial Management
Seleena Lancee

05 SHORT-TERM
FINANCING

2. Commercial Bank Loans COMMERCIAL BANK LOAN R - C

Banks are major source of unsecured 1. Revolving Credit Agreement
short-term loans to businesses. The lender sets aside funds that the
borrower can use at his discretion.
COST OF TERM LOAN/EIR
Borrowed portion - interest
Unborrowed portion - commitment
Cost of Term Loan/EIR =
fee
Interest Days in the Year
x 2. Credit Line
P - I - CB Days outstanding a one-time arrangement, and when the
credit line is paid off, the account is
Where: closed.
P = Principal
I = Interest PRIME RATE
CB = Compensating Balance The lowest rate of interest at which money
may be borrowed commercially.
*Only deduct the interest on the
COST OF INSTALLMENT LOANS
denominator if it is discounted (interest is
The borrowed amount is paid in equal
deducted in advance)
installments with interest.
PRINCIPAL/AMOUNT TO BE BORROWED
EFFECTIVE INTEREST ON INSTALLMENT LOAN
Principal/Amount to be borrowed =
Effective Interest on Installment =
Amount Needed 2 x No. of installments x Interest

( 1 - CB% - Interest% ) (1 + No. of installments) x Principal

Where:
Net Proceeds in Peso Monthly - 12
Quarterly - 4
Net proceeds in % Semi-annual - 2
Annual - 1

100% Principal COST OF COMMERCIAL PAPER

18% Interest A form of financing that consists of short-
15% Compensating Balance term, unsecured promissory notes issued by
67% Net Proceeds firms with a high credit standing.
Often non-interest bearing and are sold at a
discount.
D CB
COST OF COMMERCIAL PAPER
A Cost of commercial paper =
B D + FLC 360 or 365 days
x
C IP - FC CP - DP

ACT1124 | FInancial Management

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05 SHORT-TERM
FINANCING

Where: SECURED SOURCES

FLC = Flotation Cost
IP = Issue Price
CP = Credit Period
DP = Discount Period
UNSECURED SOURCES SUMMARY
Numerator > Financing Cost FC
Denominator > Net Proceeds NP
The Lower the financing cost, the better.
SECURED SOURCES
1. Receivable Financing
PLEDGING ACCOUNTS RECEIVABLE
Occurs when a business uses its AR asset as
collateral on a loan, usually a line of credit.
Under a pledging arrangement, the
company retains title to and is responsible
for collecting accounts receivable, not the
lender.
COST OF PLEDGING OF RECEIVABLES
1. Revolving Credit Agreement
The lender sets aside funds that the
borrower can use at his discretion.
Borrowed portion - interest
Unborrowed portion - commitment
fee
2. Credit Line
a one-time arrangement, and when the
credit line is paid off, the account is
closed.
PRIME RATE
The lowest rate of interest at which money
may be borrowed commercially.
COST OF INSTALLMENT LOANS
The borrowed amount is paid in equal
installments with interest.
EFFECTIVE INTEREST ON INSTALLMENT LOAN
Effective Interest on Installment =
2 x No. of installments x Interest

Cost of commercial paper = (1 + No. of installments) x Principal

FNC 360 or 365 days Where:
x
Monthly - 12
NP CP
Quarterly - 4
*Same with commercial loans. Semi-annual - 2
Where: Annual - 1
FNC = Financing Cost COST OF COMMERCIAL PAPER
NP = Net Proceeds
A form of financing that consists of short-
CP = Credit Period
term, unsecured promissory notes issued by
2. Inventory Financing firms with a high credit standing.
Inventory financing is credit obtained by Often non-interest bearing and are sold at a
businesses to pay upfront for products that discount.
will not be sold immediately. The loan is COST OF COMMERCIAL PAPER
collateralized by the inventory it is used to
Cost of commercial paper =
purchase.
D + FC 360 or 365 days
x
IP - FC CP - DP

ACT1124 | FInancial Management