Sources of Short-term Financing

Outline
1. Unsecured Credit a. Accruals b. Trade Credits c. Bank Loans d. Commercial Papers 2. Secured Loans a. Receivable Financing 1. Pledging 2. Assignment 3. Factoring 4. Discounting b. Inventory Financing 1. Blanket Lien 2. Chattel Mortgage 3. Warehousing

What is an unsecured credit?

It includes all those sources that have as their security only on the lenders faith in the ability of the borrower to repay the funds when due. There is no asset involved or used as collateral, and it is simply a borrower-lender relationship.

Types of Unsecured Credit

Accruals are sources of financing arise spontaneously with the firms sales. Accrued expense items provide the firm with automatic sources of financing. Since items like utilities and wages are first credited into a liability account rather than cash, they can use these cash into more important matters the company should be able to deal with. Trade Credits are one of the most flexible sources of financing available to a firm. It is a primary source of financing because it arises from ordinary business transactions. This represents a very basic borrower-lender relationship. Bank Loans. Commercial banks are second in importance to trade credit as a source of shortterm financing. As a firms financing needs increase, it requests additional funds from the bank. This is a specialized type of trade credit arrangement wherein the bank is the lender.

Commercial Papers are unsecured short-term promissory note sold in the money market by highly credit-worthy firms. The computations regarding effective rates on unsecured credits will be provided in the compilation of CPA and CMA licensure examination questions.

What are secured loans?

Secured sources of short-term credit have certain assets of the firm pledged as collateral to secure the loan.

Types of Secured Loans Receivable Financing

Pledging refers to the use of receivables as collateral for a loan, and is known as the general assignment of accounts receivable. There are no special accounting problems related to this type of secured loan. Assignment is a more formal borrowing arrangement in which specific receivables are identified and
used as security for a loan. This is also called specific assignment of accounts receivable, as the entry regarding into this transaction includes a debit to the account, Accounts Receivable Assigned, and crediting the amount of accounts receivable that was assigned, thus decreasing the amount of trade receivables.

Factoring is the outright sale of receivables. The factor company assumes the risk of collection and generally handles the billing and collection function. Discounting is endorsing a promissory note to a bank or a financing company, the latter advancing the maturity value of the note less a charge called discount.

Types of Secured Loans Inventory Financing

Blanket / Floating Lien give the lender a general lien or claim against the inventory of the borrower. Chattel Mortgage is also called Trust receipt. They are instruments acknowledging that the borrower holds the inventory and proceeds from sales in trust for the lender. Warehousing. Under this arrangement, goods are physically identified, segregated, and stored under the direction of an independent warehousing company.

Why Short-term Financing? (Advantages)

(1) Cash flow from sales might not be sufficient for growth funding needs, such as building new production capacity, adding new sales staff and opening new retail outlets. (2) Companies can plug cash shortfalls or pay for emergency funding needs if they have access to operating lines of credit and other forms of short-term financing. (3) It might be easier for businesses, especially small businesses, to secure short-term financing instead of long-term or equity financing. (4) Short-term interest rates are lower than long-term rates, which gives management more flexibility in operating their business.

Why not Short-term Financing? (Disadvantages)

(1) Rising interest rates increase borrowing costs. Businesses that rely on variable-rate short-term loans will immediately feel the effects of rising rates. (2) Asset-backed financing also involves different costs -- in addition to the interest rate and service fees, only a portion of the collateral pledged is advanced to the borrower. The lender might also require additional assets to be pledged as safeguards. (3) Businesses that use credit cards for their short-term needs might see their profit margins suffer because of higher interest rates. (4) The short-term financing might not be adequate and, for businesses that are already stretched, there might not be additional sources of funds available.

References
Cabrera, Ma. Elenita B. (2011). Management Consultancy. Conanan Educational Supply, Manila Salvador, Samuel M., Baysa, Gloria T., Gamboa, Dominador R., Fua-Geronimo, Ellinor C. (2012). Fundamentals and Applications of Financial Management. Allen Adrian Books Inc. Robles, Nenita S., Empleo, Patricia M. (2010). Intermediate Accounting, Volume 1. Millenium Books Inc., Mandaluyong City Valix, Conrado T., Peralta, Jose F., Valix, Christian Aris M. (2011). Financial Accounting, Volume 1. Conanan Educational Supply, Manila

Agamata, Franklin T. (2013). Reviewer in Management Advisory Services. Conanan Educational Supply, Manila
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Kevin Troy M. Chua BSA 4-7