SHORT-TERM CREDIT FOR

FINANCING CURRENT
ASSETS
TWO BASIC PROBLEMS IN MANAGING THE USE OF
SHORT-TERM FINANCING
1. Determining the level of short-term financing the firm
should use
2. Selecting the source of short-term financing
FACTORS IN SELECTING A SOURCE OF SHORT-TERM
FUNDS
1. The effective cost of credit.
2. The availability of credit in the amount needed and for the period of time
when financing is required.
3. The influence of the use of credit source on the cost and availability of other
sources.
4. Any additional covenants of the loans.
ESTIMATING COST OF SHORT-TERM
CREDIT
1. Cost of Trade Credit

2. Cost of Bank Loans

• Simple interestEffective annual rate Interest
simple=
Face Value – Interest

• Discount interest Interest

Effective annual rate
Amount received
discount=

2 x Annual number of payments x

• Add-on interest Interest
Approximate annual rateadd-on=
(Total number of payments +1) x
Principal
• Simple Interest with compensating balance
Interest
Effective annual rate
Face Value – Compensating
simple/CB=
balance
Nominal rate (%)
Effective annual rate
1 – Compensating balance %
simple/CB=

• Discount interest with compensating balance

Interest
Face Value – Interest – Compensating
balance
Nominal rate (%)
1 – Nominal Interest Rate – Compensating balance
%
3. Cost of Commercial Paper
Interest + Issue Cost 1
Effective annual rate discount
Face Value of note – Interest – Issue x Days to maturity / 360
=
Cost days