Short-term financing
Lecture for Corporate Finance
Ing. Tomáš Heryán, Ph.D.
Corporate Finance
FIU/BAFIK
Outline of the lecture
• Short-term financing
• Selected types from debt-financing
• Reasons
• Working capital management
• Selected types of internal financing
Short-term financing
All corporations make short-term
financing decisions periodically.
Beyond the trade financing, firms
obtain short/term financing
decisions to support other
operations.
Because MNCs have an access to
additional sources of funds, their
short-term financing decisions are
more complex than those of other
companies.
Financial managers must understand the
possible advantages and disadvantages
of short-term financing with foreign
currencies so that they should make
short-term financing decisions that
maximize the value of the company.
In businesses, it is also known as
working capital management. This type
of financing is normally needed because
of uneven flow of cash into the business,
the seasonal pattern of business, etc. In
most cases, it is used to finance all types
of inventory, accounts receivables etc. At
times, only specific one time orders of
business are financed.
Spontaneous financial sources
• Spontaneous are financial sources which are arising without any
contract. These are commercial credits and accruals.
• Commercial credits are credits arisen from relationship between
supplier and customer, where the supplier gives some deadline till it is
necessary to pay a bill. Within this period the customer have a product
and money being paid for this product and they can use both.
• Accruals are for example employees’ salaries which are paid with
delay. Until their pay-off the company can use them.
Contracting financial sources
Contracting financial sources is based on contracts. There are bank loans, operative
leasing, issue of short-term securities and factoring.
A common type of business loan is the working capital loan (sometimes called a selfliquidating
loan), which is designed to support ongoing business operations. There is a
lag between the time when a firm needs cash to purchase raw materials used in
production and the time when it receives cash inflows from the sales of finished
products.
A working capital loan can support the business until sufficient cash inflows are
generated. These loans are typically short term, but they may be needed by businesses
on a frequent basis
Working capital
• Working capital is not a typical short-term financial source.
• It represents operating liquidity available to a business. Along with
fixed assets (e.g. equipment), working capital is considered a part of
operating capital.
• A company needs that current assets exceed its current liabilities.
• If not, then it may run into trouble paying back creditors in the short
term.
The level of working capital
The level of working capital depends on company’s policy. An aggressive policy means
that a company chooses to operate with lower levels of shares, debtors and cash for a
given level of activity or sales.
The aggressive policy will increase profitability since less cash will be tied up in
current assets, but it will also increase risk since the possibility of cash shortages or
running out of share is increased.
A conservative and more flexible working capital policy would be associated with
maintaining a larger cash balance, perhaps even investing in short-term securities,
offering more generous credit terms to customers and holding higher level of share.
Risk will be reduced but at the expense of reducing profitability. A moderate policy
would tread a middle path between the previous approaches.
Company’s policy
Company’s policy
Company’s policy
It is very simple, if the firm is maximizing sales
while maximizing the level of working capital, it
is very safe and that working capital
management is very conservative.
In contrary, if the level is very small, it means
risk and aggressive working capital management.
Financing working capital
To assist in the analysis of policy decisions on the financing of working capital, we can
divide a company’s assets into three different types: fixed assets, permanent current
assets and fluctuating current assets.
Fixed assets are long-term assets such as buildings, machinery from which a company
expects to derive benefit over several periods.
Permanent current assets represent the core level of investment needed to sustain
normal levels of trading activity, such as investment in stocks and investment in the
average level of company’s debtors.
Fluctuating current assets correspond to the variations in the level of current assets
arising from normal business activity.
Different approaches to financing of working capital
Financing of working capital
Financing of working capital
Maturity matching or hedging approach is a
strategy of working capital financing wherein
short term requirements are met with short-term
debts and long-term requirements with long-term
debts. The underlying principal is that each asset
should be compensated with a debt instrument
having almost the same maturity.
FA – Fixed assets
PCA – Permanent current assets
FCA – Fluctuating current assets
Operative leasing
• An operative leasing is short-term leasing used often for buying
equipment, or devices, which could become quite quick very old and
unsightly.
• The company does not have to buy it, but only lease it for several
years and repeat it.
• In this way its equipment is still on the latest or technical acceptable
state.
Factoring
• Factoring is a financial transaction which leads to getting money. A
company sells its accounts receivables (invoices) to a third party
(called a factor) at a discount.
• In the figure at next slide is an example of a possible contract between
factoring company and business company and description, how their
relationship works.
• In case of non-recourse factoring the factor, rather than the company,
carries the risk of bad debts.
Process of Factoring
Process of Factoring
Process of Factoring
For a customer it is not any difference there
cause it is just a payment for goods and services.
There is a bit complicated relation between
Supplier (a firm), and a finance company
offering the factoring.
How does Factoring work?
• 1. Supplier signs a factoring contract with CSOB Factoring and becomes
its client.
• 2. Goods or services are supplied to a Customer. Supplier issues an
invoice with a cession clause and sends off an original to the Customer.
• 3. Then Supplier assigns his claims to CSOB Factoring, which implies
that his Customer becomes a debtor of CSOB Factoring.
• 4. Supplier (client) has the right to draw an advance payment up to 90 %
of nominal value of the claim including VAT.
• 5. When the claim is due, Customer is obliged to pay on CSOB Factoring
account.
• 6. The difference up to 100 % of nominal value of the claim is paid to
Client the same day when CSOB Factoring receives the payment from
Customer (debtor).
Sources of short-term financing – debt financing in foreign currency
Companies’ parents and their subsidiaries typically use various methods of obtaining
short-term funds to satisfy their liquidity needs.
When financing in a foreign currency, it is increasingly the case that the bank or
financial market providing the finance will not be in the country of the currency.
When this is the case term euro is used. Thus a eurodollar bank account is an account
that will probably be situated in London and will be denominated in dollars. A
eurobank is a bank that makes loans and accepts deposits in foreign currencies.
Eurobank loans
• Direct loans from eurobanks, which are typically utilized to maintain
a relationship with eurobanks, are another popular source of shortterm
funds for companies.
• If other sources of short-term funds become unavailable, firms rely
more heavily on direct loans from eurobanks.
• Most companies maintain credit arrangements with various banks
around the world.
• Some firms have credit arrangements with more than 100 foreign and
domestic banks.
Euronotes
• Euronotes, or unsecured debt securities, are bonds issued by firms
with an interest payment and fixed term after which the firms will
repay the nominal (agreed) amount.
• The interest rates on these notes are based on LIBOR. Euronotes
typically have maturities of 1, 3, or 6 months. Some companies
continually role them over as a form of intermediate-term financing.
It means they issue new Euronotes to repay ones that are maturing
and need to be repaid by the company.
• The companies in this way extend the term of the loan to themselves.
Commercial banks underwrite (guarantee) notes for firms and some
commercial banks purchase them for their own investment portfolios.
Euro-commercial paper
It is promissory note (an IOU note) issued by large reputable company needing to
borrow for a very short term or any stated length usually about 180 days but can be for
1 year.
It is a bearer note, which means the holder is the owner rather like a currency note such
as 5,- GBP only when these notes are for a minimum of 500.000,- USD.
Dealers issue this paper for the firm without the backing of an underwriting syndicate,
so a selling price is not guaranteed to the issuers. Maturities can be tailored to the
issuer´s preferences. Dealers make a secondary market by offering to repurchase eurocommercial
paper before maturity.
Internal financing by firms 1/2
Before a firm´s parent or subsidiary in need of funds searches for outside funding, it
should check other subsidiaries´ cash flow positions to determine whether any internal
funds are available.
This process is especially useful during periods when the cost of obtaining funds in the
parent´s home country is relatively high.
Parents of companies can also attempt to obtain financing from their subsidiaries by
increasing the mark-ups on supplies they send to the subsidiaries.
Internal financing by firms 2/2
In the case of internal financing, the funds the subsidiary gives to the parent will never
be returned. This method of supporting the parent can sometimes be more feasible than
obtaining loans from the subsidiary because it may circumvent restrictions or taxes
imposed by national governments.
In some cases, though, this method itself may be restricted or limited by host
governments where subsidiaries are located. The practice may also transgress double
taxation agreements where intra (within) a company trade should be conducted
„at arm´s-length“, i.e. as if they were independent companies.
Why do firms consider
foreign currency
financing?
Regardless of whether a parent or
subsidiary decides to obtain
financing from subsidiaries or from
some other source, it must also
decide which currency to borrow.
Even if it needs its home currency, it
may prefer to borrow a foreign
currency for these reasons:
Foreign financing to offset foreign
currency inflows, when a large firm may
finance in foreign currency to offset a
net receivables position in that foreign
currency.
Foreign financing to reduce costs – even
when a firm is not attempting to cover
foreign net receivables, it may still
consider borrowing foreign currencies if
the interest rates on those currencies are
relatively low and the currency stable.
Comparison of the monthly GBP cost and Swiss franc loan
The monthly GBP cost and Swiss franc loan
Comparison of two loans
We see especially different volatility of both
rates, which means that Swiss market is exactly
less risky. Especially due to the Global financial
crisis, the Swiss interest rates decreased.
Therefore, loans in Swiss franc were highly
demanded by huge corporations and this
currency was still appreciating during the crisis.
Exchange rate forecasts
While the forecasting capabilities of firms are somewhat limited, some firms may make
a decisions based on their estimation of the future value of the currency. In looking to
future two approaches are common:
• Develop a probability distribution – looking at the varying rates and
their probabilities, using the standard deviation and also covariance
and correlation.
• Access scenarios – not confined to predicting the value of exchange
rate. There may, for instance, be a series of scenarios whereby the
value of the foreign currency falls by 5%, but the differences in
scenarios is what will happening to other exchange rates or to
international regulations or government policies. So this approach is
more than merely approximating a distribution of exchange rates.
Literature:
1) MADURA, J., FOX, R., 2014. International Financial Management. Mason etc.:
South-Western Publishing., pp. 579-600. ISBN 978-1-4080-7981-2.
2) ROSS, S. A., R. W. WESTERFIELD, J. JAFFE & B. D. JORDAN, 2019. Shortterm
Finance. In: Corporate Finance, Part VII, pp. 795-876. ISBN 978-1-260-
09187-8.
3) BERK, J. & P. DeMARZO, 2017. Short-term Financing. In: Corporate Finance,
Part 9, pp. 950-973. ISBN 978-1-292-16016-0.
Thank you for
your attention!
