CIMA F1 Syllabus D. Management Of Working Capital And Cash - Short term finance - Notes ^{1 / 1}

The following are short terms forms of finance

- in the exam always remember to think about these when asked about possible ways of raising finance

1. Overdraft

   This is the riskiest type of finance as the bank can call it in at any time.

   The bank has the right to be repaid overdrawn balances on demand, except where the overdraft terms require a period of notice.

   The bank can use the customers’ money in any legally or morally acceptable way that it chooses.

   One advantage of an overdraft over a short term loan is that the terms of an overdraft can be renegotiated at short notice.

2. Short term Loan

   Less risky than an overdraft but it will possibly need replacing and there’s a risk that it would be on worse terms - if the economy changes

3. Trade payables

   Often seen as free finance - although you may actually be missing out on early settlement discounts. 

   Be careful also not to annoy your creditors by taking too long to pay

4. Debt Factoring

   The sale of a business' invoices to a third party. 

   The business selling will pay a fee for this service

   The third party is charged with processing the invoices, and the business lending the invoices is able to receive loans based on the expected payments on the invoices.

5. Invoice discounting

   this is similar to factoring expect that the discounter does not manage the receivables ledger.

This is a useful source of finance for the following reasons:

• Protection against obsolescence 

  Since it can be cancelled at short notice without financial penalty. 

  The lessor will replace the leased asset with a more up-to-date model in exchange for continuing leasing business.

  This flexibility is seen as valuable in the current era of rapid technological change, and can also extend to contract terms and servicing cover

• Less commitment than a loan 

  There is no need to arrange a loan in order to acquire an asset and so the commitment to interest payments can be avoided, existing assets need not be tied up as security and negative effects on return on capital employed can be avoided

  Operating leasing can therefore be attractive to small companies or to companies who may find it difficult to raise debt.

• Cheaper than a loan 

  By taking advantage of bulk buying, tax benefits etc the lessor can pass on some of these to the lessee in the form of lower lease rentals, making leasing a more attractive proposition that borrowing.

Short term investments include:

1. Bills of exchange

   It is essentially a written acknowledgement of the debt between a customer and a supplier. The bill can be held, sold to a bank or transferred to pay off a debt.

   Bills of exchange are often used for export financing.

2. Certificates of deposit

   It is a fixed-term investment, carrying a fixed rate of interest.

3. Interest bearing deposits

   A low risk investment where a company can deposit excess funds and receive interest on the amount deposited.

4. Short-term treasury bills

   A company can purchase treasury bills issued by governments. The company pays less than the face value that is repaid on maturity,

5. Commercial paper

   It is a fixed-term investment of less than 270 days, which is purchased at a discount. The interest rate is higher for longer dated commercial papers.

6. Short term bonds

7. Trade receivables

Calculation of interest

It is done using compound interest calculation.

x(1+r)^n
where
x is amount invested
r is interest rate
n is period

Illustration

Cow invests $40,000 in a bank account for 5 years at an interest rate of 4%. 

How much will be in the account at the end of the 5 year period?

x(1+r)^n
40,000 (1+0.04)^5
$48,666