Sources of Short-term Financing by Levone

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									Sources of Finance

       Chapter 4
In this chapter we will examine the
types of financing available to
businesses in Australia.
Short term financing refers to finance
that must be repaid within one year.
Types of short term credit include trade
credit, bank overdraft, commercial bills,
promissory notes, inter-company loans,
factoring and leasing.
         Trade Credit
Trade credit refers to the period that a
vendor allows before payment is
This type of finance is widely used
 No interest charge is made by the lender;
 It is relatively easy to obtain by businesses
  with a good credit rating; and
 Being tied to the purchases of a business,
  the level of financing automatically grows
  as the business expands.
The normal terms of trade credit are ‘net
30 days’, or in other words, the invoice
must be paid in full within thirty days.
Sometimes a discount is offered to
customers for early payment.
One method of extending trade credit is
known as ‘stretching’. This is the
practice of postponing payments to
creditors beyond the originally agreed
period of time. This may be accepted
by the supplier especially if the business
is a regular customer.
     Bank Overdrafts
A bank overdraft is an arrangement
whereby the bank agrees to allow a
business to overdraw its account up to a
specified amount called the ‘overdraft
The business has the freedom to
overdraw the account up to the
overdraft limit, and then replenish the
account when funds become available.
Interest is calculated daily on
outstanding balances and is charged to
customers twice a year.
Overdrafts under $100,000 are subject
to interest rate limits, imposed by the
government, while interest rates for
overdrafts of $100,000 or over are
usually determined by market prices.
In reality interest rates for overdrafts are
usually arrived at through negotiations
between the bank and the customer.
 The overdraft limit and rate of interest,
 being subject to negotiations between
 the bank and customer, are usually
 dependant on three factors:
1. The bargaining position of the
2. The financial standing of the
3. The security given.
    Commercial Bills
Commercial bills are the means by
which amounts of $100,000 or more can
be borrowed for periods normally
ranging from 90 to 180 days.
Commercial bills are bills of exchange
that are drawn with the express purpose
of providing finance to a business.
Commercial bills have three parties: the
drawer, the acceptor and the
The drawer is the party which draws up
the bill requiring payment.
The acceptor is the party which agrees
to pay the drawer.
The discounter is the party lending the
funds to the acceptor.
Figure 4.1 shows the commercial bill
    Promissory Notes
The issue of promissory notes is a
means of borrowing that is normally
only available to companies with a very
good reputation.
This is because only one name (the
borrower’s) name appears on a
promissory note and any holder relies
on the standing of the promissor for
The seller of a promissory note
therefore incurs no contingent liability, in
contrast with the case when a bill of
exchange (commercial bill) is sold.
To obtain funds, a company executes a
promissory note and then has it
underwritten by a merchant bank which
arranges for tenders from a number of
lenders. Alternatively, the company
may approach the market itself.
The successful buyer of the note pays a
face value minus a discount fee to the
On the due date the borrower pays the
face value of the note to who ever is the
holder at the time.
The amount borrowed by means of a
promissory note will be at least
$100,000 and often in the tens of
millions, while the maturity period will
normally range from 30 to 180 days.
 Inter-Company Loans
The inter-company market is an
informal market where amounts of
$100,000 and upwards can be
borrowed at call or for short fixed terms.
Lending on this market is unsecured,
thus the borrower must be financially
sound and well known to the lender.
Due to seasonal nature of many
businesses, a company with surplus
funds to lend at one time of the year
may be able to borrow funds at another
time of the year form the same
company it lent to earlier.
The rates of interest paid on inter-
company loans are usually below the
bank overdraft rate, although they may
rise above it during periods of tight
Factoring refers to either the
assignment or the sale of accounts
receivable to a finance company.
In the case of an assignment, the
finance company makes a loan with the
accounts receivable as a security and
then collects payment on those
accounts as repayment of the loan.
In the case that a customer defaults on
a payment, the finance company has
recourse to the borrower, who must
make up the loss.
In the case of a sale, the finance company
becomes the legal owner of the accounts
receivable and has no recourse if the
customer defalts
In Australia receivables are generally
assigned rather than sold
   Expensive form of finance
   Seller has no say in the collection policies of the
   Often considered the last-resort method of finance
    which may effect the reputation of the seller
 Factoring has three main drawbacks.
1. It is an expensive form of finance.

2. Because it is expensive, it is often
   regarded as being a last-resort
   method of financing and thus may
   affect the reputation of a company if
   it is known that it is using factoring.
3. The collection of accounts is taken
   out of the hands of the seller, who
   has no say in the collection policies
   of the factor.
Leasing is a form of short term finance
is regularly used to acquire the use of
assets without having to purchase them.
Leasing is widely used to obtain the
short term use of a wide range of plant,
machinery, equipment, vehicles and
The lessee obtains the use of such
assets by payment of lease rentals to
the lessor.
This is an effective way of financing the
use of an asset which is only needed for
a short time.

Problem 4.1
Problem 4.2
Problem 4.3
Problem 4.7

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