? 2002,Prentice Hall,Inc,
Ch,18,
Management
and Short-Term Financing
Working-Capital Management
? Current Assets
– cash,marketable securities,inventory,
accounts receivable
? Long-Term Assets
– equipment,buildings,land
? Which earn higher rates of return?
? Which help avoid risk of illiquidity?
Working-Capital Management
? Current Assets
– cash,marketable securities,inventory,
accounts receivable
? Long-Term Assets
– equipment,buildings,land
? Risk-Return Trade-off,
Current assets earn low returns,but
help reduce the risk of illiquidity,
Working-Capital Management
? Current Liabilities
– short-term notes,accrued expenses,
accounts payable
? Long-Term Debt and Equity
– bonds,preferred stock,common stock
? Which are more expensive for the firm?
? Which help avoid risk of illiquidity?
Working-Capital Management
? Current Liabilities
– short-term notes,accrued expenses,
accounts payable
? Long-Term Debt and Equity
– bonds,preferred stock,common stock
? Risk-Return Trade-off,
Current liabilities are less expensive,
but increase the risk of illiquidity,
Balance Sheet
Current Assets Current Liabilities
Fixed Assets Long-Term Debt
Preferred Stock
Common Stock
To illustrate,let’s finance all current assets
with current liabilities,
Balance Sheet
Current Assets Current Liabilities
Fixed Assets Long-Term Debt
Preferred Stock
Common Stock
To illustrate,let’s finance all current assets
with current liabilities,
Balance Sheet
Current Assets Current Liabilities
Fixed Assets Long-Term Debt
Preferred Stock
Common Stock
To illustrate,let’s finance all current assets
with current liabilities,and finance all
fixed assets with long-term financing,
Balance Sheet
Current Assets Current Liabilities
Fixed Assets Long-Term Debt
Preferred Stock
Common Stock
To illustrate,let’s finance all current assets
with current liabilities,and finance all
fixed assets with long-term financing,
Balance Sheet
Current Assets Current Liabilities
Fixed Assets Long-Term Debt
Preferred Stock
Common Stock
Balance Sheet
Current Assets Current Liabilities
Fixed Assets Long-Term Debt
Preferred Stock
Common Stock
Suppose we use long-term financing to
finance some of our current assets,
Balance Sheet
Current Assets Current Liabilities
Fixed Assets Long-Term Debt
Preferred Stock
Common Stock
Suppose we use long-term financing to
finance some of our current assets,
Balance Sheet
Current Assets Current Liabilities
Fixed Assets Long-Term Debt
Preferred Stock
Common Stock
Suppose we use long-term financing to
finance some of our current assets,
This strategy would be less risky,but more
expensive!
Balance Sheet
Current Assets Current Liabilities
Fixed Assets Long-Term Debt
Preferred Stock
Common Stock
Balance Sheet
Current Assets Current Liabilities
Fixed Assets Long-Term Debt
Preferred Stock
Common Stock
Suppose we use current liabilities to finance
some of our fixed assets,
Balance Sheet
Current Assets Current Liabilities
Fixed Assets Long-Term Debt
Preferred Stock
Common Stock
Suppose we use current liabilities to finance
some of our fixed assets,
Balance Sheet
Current Assets Current Liabilities
Fixed Assets Long-Term Debt
Preferred Stock
Common Stock
Suppose we use current liabilities to finance
some of our fixed assets,
This strategy would be less expensive,but
more risky!
The Hedging Principle
? Permanent Assets (those held > 1 year)
– should be financed with permanent and
spontaneous sources of financing,
? Temporary Assets (those held < 1 year)
– should be financed with temporary
sources of financing,
Balance Sheet
Temporary
Current Assets
Balance Sheet
Temporary Temporary
Current Assets Short-term financing
Balance Sheet
Temporary Temporary
Current Assets Short-term financing
Permanent
Fixed Assets
Balance Sheet
Temporary Temporary
Current Assets Short-term financing
Permanent Permanent
Fixed Assets Financing
and
Spontaneous
Financing
The Hedging Principle
? Permanent Financing
– intermediate-term loans,long-term debt,
preferred stock,common stock
? Spontaneous Financing
– accounts payable that arise spontaneously
in day-to-day operations (trade credit,
wages payable,accrued interest and taxes)
? Short-term financing
– unsecured bank loans,commercial paper,
loans secured by A/R or inventory
Cost of Short-Term Credit
Interest = principal x rate x time
ex,borrow $10,000 at 8.5% for 9 months
Interest = $10,000 x,085 x 3/4 year
= $637.50
We can use this simple relationship,
Interest = principal x rate x time
to solve for rate,and get the
Cost of Short-Term Credit
We can use this simple relationship,
Interest = principal x rate x time
to solve for rate,and get the
Annual Percentage Rate (APR)
Cost of Short-Term Credit
APR = x
We can use this simple relationship,
Interest = principal x rate x time
to solve for rate,and get the
Annual Percentage Rate (APR)
interest 1
principal time
Cost of Short-Term Credit
Cost of Short-Term Credit
APR = x interest 1 principal time
Cost of Short-Term Credit
APR = x interest 1 principal time
example,If you pay $637.50 in
interest on $10,000 principal for 9
months,
Cost of Short-Term Credit
APR = x interest 1 principal time
example,If you pay $637.50 in
interest on $10,000 principal for 9
months,
APR = 637.50/10,000 x 1/.75 =,085
= 8.5% APR
Cost of Short-Term Credit
Annual Percentage Yield (APY) is
similar to APR,except that it
accounts for compound interest,
Cost of Short-Term Credit
APY = ( 1 + ) - 1
Annual Percentage Yield (APY) is
similar to APR,except that it
accounts for compound interest,
i m
m
Cost of Short-Term Credit
APY = ( 1 + ) - 1
Annual Percentage Yield (APY) is
similar to APR,except that it
accounts for compound interest,
i m
m
i = the nominal rate of interest
m = the # of compounding periods per year
Cost of Short-Term Credit
Cost of Short-Term Credit
What is the (APY) of a 9% loan with
monthly payments?
APY = ( 1 + (,09 / 12 ) 12 -1 ) =,0938
= 9.38%
Sources of Short-term Credit
? Unsecured
Sources of Short-term Credit
? Unsecured
–accrued wages and taxes
Sources of Short-term Credit
? Unsecured
–accrued wages and taxes
–trade credit
Sources of Short-term Credit
? Unsecured
–accrued wages and taxes
–trade credit
–bank credit
Sources of Short-term Credit
? Unsecured
–accrued wages and taxes
–trade credit
–bank credit
–commercial paper
Sources of Short-term Credit
? Unsecured
–accrued wages and taxes
–trade credit
–bank credit
–commercial paper
? Secured
Sources of Short-term Credit
? Unsecured
–accrued wages and taxes
–trade credit
–bank credit
–commercial paper
? Secured
–accounts receivable loans
Sources of Short-term Credit
? Unsecured
–accrued wages and taxes
–trade credit
–bank credit
–commercial paper
? Secured
–accounts receivable loans
–inventory loans