Monday, 26 November 2012

ž INTERMEDIATE-TERM FINANCING


ž Intermediate-term financing
ž Whereas short-term loans are repaid in a period of weeks or months, intermediate-term loans are scheduled for repayment in 1 to 15 years. Obligations due in 15 or more years are thought of as long-term debt. The major forms of intermediate-term financing include (1) term loans, (2) conditional sales contracts, and (3) lease financing.

ž Economic Role of a debt

ž What Business Owners Need
ž Before giving business owners intermediate-term loans, banks want to know how much capital the businesses have. Lenders want to see assets that can be turned into cash quickly. Lenders can rely on these liquid assets to repay their loans in the event that a business owner defaults on payments. A business owner's capital may include apartment buildings, other real estate and stocks.
ž A Strong Business Plan
ž Lenders will also want to see a strong business plan before lending money. They'll be especially interested in the expenses and revenues that business owners project for their ventures. If these figures seem poorly researched, the odds are good that lenders will pass.
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ž Definition of 'Term Loan
ž A loan from a bank for a specific amount that has a specified repayment schedule and a floating interest rate. Term loans almost always mature between one and 10 years.
ž For example many banks have term-loan programs that can offer small businesses the cash they need to operate from month to month. Often a small business will use the cash from a term loan to purchase fixed assets such as equipment used in its production process.

ž Characteristics of term loan
ž Credit is extended under a formal loan arrangement.
ž Usually payments that cover both interest and principal are made quarterly, semiannually, or annually.
ž The repayment schedule is geared to the borrower’s cash-flow ability and may be amortized or have a balloon payment.
ž Conditional Sales Contracts
ž A sale of an asset in which the buyer assumes possession and may have use of the asset, but the seller retains title until the buyer pays its full price and may repossess the asset if the buyer does not. In exchange for the right to use the asset, the buyer makes payments over an agreed-upon period of time, whether months or years. This arrangement is most common with heavy equipment, machinery, and real estate.
 ž lease
  
ž Definition
ž Written or implied contract by which an owner (the lessor) of a specific asset (such as a parcel of land, building, equipment, or machinery) grants a second party (the lessee) the right to its exclusive possession and use for a specific period and under specified conditions, in return for specified periodic rental or lease payments. A long-term written lease (also called a deed) creates a leasehold interest which in itself can be traded or mortgaged, and is shown as a capital asset in a firm's books.

ž Advantages of Leasing:

Leasing offers fixed rate financing; you pay at the same rate each month
Leasing is inflation friendly. As the costs go up over five years, you still pay the same rate as when you began the lease, therefore making your dollar stretch farther.There is less upfront cash outlay; you do not need to make large cash payments for the purchase of needed equipment.
Leasing better utilizes equipment; you lease and pay for equipment only for the time you need it (until the end of the lease).
There is typically an option to buy equipment at end of the term of the lease
 You can keep upgrading; as new equipment becomes available you can upgrade to the latest models each time your lease ends
It is easier to obtain lease financing than loans from commercial lenders (in most cases).

It offers potential tax benefits depending on how the lease is structured.
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ž Disadvantages of Leasing:

ž  Leasing is a preferred means of financing for many businesses. However, it is not for every business. The type of industry and type of equipment required also need to be considered. Tax implications also need to be compared between leasing and purchasing equipment outright.You have an obligation to continue making payments. Typically, leases may not be terminated before the original term is completed. The renter is responsible for paying off the lease. This can create a major financial problem for the owner of a business experiencing a downturn.
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You have no equity until you decide to purchase the equipment at the end of the lease term, at which point the equipment may have depreciated significantly.
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Although you are not the owner, you are still responsible for maintaining the equipment as specified by the terms of the lease.

ž Finance Lease

ž Fixed-term lease, usually noncancellable, used by businesses in financing capital equipment. The lessor's service is limited to financing the asset, whereas the lessee pays all other costs, including maintenance and taxes, and has the option of purchasing the asset at the end of the lease for a nominal price. It is also called a full-payout lease because the lease is fully paid out (amortized) over its lifetime.
ž Finance Lease
 Finance lease, also known as Full Payout Lease, is a type of lease wherein the lessor transfers substantially all the risks and rewards related to the asset to the lessee. Generally, the ownership is transferred to the lessee at the end of the economic life of the asset. Lease term is spread over the major part of the asset life. Here, lessor is only a financier. Example of a finance lease is big industrial equipment.

ž Operating Lease
ž             On the contrary, in operating lease, risk and rewards are not transferred completely to the lessee. The term of lease is very small compared to finance lease. The lessor depends on many different lessees for recovering his cost. Ownership along with its risks and rewards lies with the lessor. Here, lessor is not only acting as a financier but he also provides additional services required in the course of using the asset or equipment. Example of an operating lease is music system leased on rent with the respective technicians.
ž Importance of Short Term Debt
ž The short term debts are also called current liabilities. The current liabilities are outstanding dues that need to be paid to the creditors, as well as the suppliers. The payments need to be made within a short span of time. The current liabilities are normally paid by the companies utilizing their assets.
ž liabilities
ž The liabilities refer to the legal obligations of a company.

The liabilities are an important part of the business of the company as they are often employed in order to make bigger payments, as well as execute business activities. The liabilities play an important role in increasing the efficacy of the business deals being undertaken by companies.

ž Uses of short term debt
ž Operating Capital
ž Operating capital is defined as cash available to pay for the day-to-day operations of a business. Ideally, operating capital is available from the revenue generated by business operations. During the initial period a business is in operation, and at other times during its existence, revenue may not keep up with operational expenses. One of the advantages of short-term debt is ensuring that cash is available to satisfy the operating capital needs of a business. Short-term debt literally is used to keep a business running during times when the revenue stream temporarily is insufficient to meet operational needs.
ž Emergency Funding
ž There is no way a business owner or manager can plan for every possible emergency situation. Although a business ideally maintains a reserve cash fund to at least deal with some expenses associated with an emergency situation, such an account is not always possible or funded sufficiently. Short-term debt assists a business in dealing with an emergency situation, according to "How to Get the Financing for Your New Small Business" by Sharon L. Fullen. For example, if a piece of equipment at a manufacturing business fails, short-term debt allows for the replacement of the hardware.
ž Expansion
ž Few business owners start a venture with the idea that it will remain the same size into the future. Most business owners desire at least some degree of expansion. Short-term debt provides a business with ready cash to initiate an expansion program, according to "Loan Financing Guide for Small Business Owners." For example, short-term debt is used to lease additional space to house the business' growing operations.
ž Advantages of short term debt
Quick Repayment
ž Short-term loans give borrowers the opportunity to purchase a new item quickly and to pay it off quickly as well. This limits the overall interest expense incurred by the borrower and allows him to quickly build equity in the item. Additionally, if the item is a depreciating asset, such as an automobile, the short repayment allows the borrower to repay the debt before the asset is worth less than the balance of the loan.
ž Advantages of short term debt
ž Flexibility
ž Short-term loans, such as credit cards and lines of credit, tend to be the most flexible modes of lending available on the market today. Each allows a borrower to purchase items at her own discretion, without needing lender approval. Additionally, the balance can be charged up and paid down and charged up again, as the borrower desires.
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Advantages of short term debt
ž Less Paperwork and Fees
ž With short-term notes, significantly less paperwork is needed to process the debt. For example, a credit card merely requires an application in most cases, with no backup documentation. A mortgage, however, requires an application with backup documentation including tax returns, bank statements and pay stubs. Additionally, there are few fees associated with the opening of a short-term loan, other than nominal opening fees in some cases. However, with a mortgage debt, the fees average between 3 and 6 percent of the loan amount.
ž No interference in management
ž The lenders of short-term finance cannot interfere with the management of the borrowing Sources of Short term Finance concern. The management retain their freedom in decision making.
ž Advantages of short term debt
ž May also serve long-term purposes : Generally business firms keep on renewing short-term credit, e.g., cash credit is granted for
one year but it can be extended upto 3 years with annual review.
After three years it can be renewed. Thus, sources of short-term finance may sometimes provide funds for long-term purposes.
 Reasons for using long term debt
ž In the modern economy, a common thread often links individuals, nonprofits, businesses and government agencies: the need to find cash to finance short-term activities, but also the urgency to raise money for long-term financial stability. Perhaps the overarching factor in using long-term debts comes from the fact that these liabilities give borrowers peace of mind in the short term. Debtors can then focus on what matters the most: making money to grow operating activities and be financially stable to repay long-term debts. Using long-term debt is also advantageous in the sense that a borrower can lock in a fixed interest rate in the short term, a situation that might prove profitable if the cost of money rises in the future.
ž External Factors
ž External factors, which mainly relate to the state of the economy, affect the use of long-term debt. Things like conditions on credit markets and investors' risk appetite affect the way consumers and businesses evaluate their future economic prospects. Monetary policies that financial regulators -- such as the Federal Reserve -- promulgate also have an impact on interest rates and the money supply in the economy.
ž Internal Considerations
ž Internal factors play a key role in determining a borrower's propensity to use short- or long-term debts. For example, the prospective debtor's financial situation may encourage the borrower to seek a long-term loan. If the borrower has a good credit score and excellent solvency ratios but is facing a temporary cash crunch, a long-term loan may be the ideal solution.

ž Business Appraisal by Discounting its Cash Flow
ž This offers some useful insights:
ž You can use the current year's business earnings and earnings growth rate as your business valuation inputs.
ž The capitalization rate is just the difference between the discount rate and the business earnings growth rate.

ž Sources of short term debt
ž If business earnings vary significantly over time, your best bet is to rely on discounting when valuing a business. Since you can make accurate earnings projections only so far into the future, the typical procedure is this:
ž Make your business earnings projections, e.g. 3-5 years into the future.
ž Assume that at the end of this period business earnings will continue growing at a constant rate.
ž Discount your projected business earnings.
ž Capitalize the earnings beyond this point. This gives you the so-called residual or terminal business value.

ž benefits from factoring
The level of benefit from factoring will vary from business to business.
But it usually provides:

* Immediate cash-flow access to 70-90 percent of the value of debtor invoices.
* Working capital for growth without requirements for a strong balance sheet or substantial net worth.
* A good interface with the supplier and, as a result, a seamless transaction for the customer.
* Outsourced debtor administration and associated cost savings.
* The ability to increase sales by offering credit which the business may have been unable to fund otherwise.
* The ability to take advantage of creditor discount terms, improve credit rating by being able to pay creditors promptly and an enhanced ability to capitalize on larger orders as required.
* The option to free up property from being tied as security