Fm Current Liabilities Management

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  • Topic: Loan, Debt, Annual percentage rate
  • Pages : 20 (4391 words )
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  • Published : October 30, 2011
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CHAPTER 15

Current Liabilities Management

INSTRUCTOR’S RESOURCES

Overview

This chapter introduces the fundamentals and describes the interrelationship of net working capital, profitability, and risk in managing the firm's current liability accounts. The management of current liabilities requires choosing appropriate levels of financing and involves trade-offs between risk and profitability. This chapter also reviews sources of secured and unsecured short-term financing, including the role of international loans. Spontaneous sources, such as accounts payable and accruals, are differentiated from negotiated bank sources, such as lines of credit. The cash discount offered on accounts payable and the cost of forgoing the discount are described. Secured sources include bank and commercial finance company loans backed by collateral such as inventory or accounts receivable.

PMF DISK

This chapter's topics are not covered on the PMF Tutor or the PMF Problem-Solver.

PMF Templates

The following spreadsheet template is provided:

ProblemTopic
15-8Cost of bank loan
Study Guide

The following Study Guide examples are suggested for classroom presentation:

ExampleTopic
1Loss of loan discounts
4Accounts receivable as collateral
ANSWERS TO REVIEW QUESTIONS

15-1The two key sources of spontaneous short-term financing (financing that arises from the normal operating cycle) are accounts payable and accruals. Both of these sources are spontaneous, since their levels increase and decrease directly with increases or decreases in sales. If sales increase, the firm will purchase more new materials, resulting in higher accruals of these items.

15-2There is no cost(stated or unstated(associated with taking a cash discount; there is a cost of giving up a cash discount. By giving up a cash discount, the purchaser pays the full price for merchandise but can make the payment later. The unstated cost of giving up a cash discount is the implied rate of interest paid to delay payments. This rate can be used to make decisions with respect to whether or not the discount should be taken. If the cost of giving up the cash discount is greater than the cost of borrowing short-term funds, the firm should take the discount. Cash discounts can be a source of additional profitability for a firm. However, some firms, either due to lack of alternative funding sources or ignorance of the true cost, do not take advantage of these discounts.

15-3Stretching accounts payable is the process of delaying the payment of accounts payable for as long as possible without damaging the firm’s credit rating. Stretching payments reduces the implicit cost of giving up a cash discount.

15-4The prime rate of interest, which is the lowest rate charged on business loans to the best business borrowers, is usually used by the lender as a base rate to which a premium is added by the lender, depending upon the risk of the borrower, in order to determine the rate charged. A floating-rate loan has its interest tied to the prime rate. The rate of interest is established at an increment above the prime rate and floats at that increment above prime over the term of the note.

15-5The effective interest rate is the actual rate of interest paid for the period. The calculation of this rate depends on whether interest is paid at maturity or in advance (deducted from the loan so that the borrower receives less than the requested amount). When interest is paid at maturity, the effective interest rate is equal to: [pic]

The effective interest rate when interest is paid in advance–a discount loan–is calculated as follows: [pic]

Paying interest in advance raises the effective rate above the stated rate.

15-6A single-payment note is an unsecured loan from a commercial bank. It usually has a short maturity(30 to 90 days(and the interest rate is normally tied in some way to the prime rate of interest. The...
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