B2 M5

Common debt covenants include:

(positive- something borrower will do; negative - something borrower will not do) -Limit on issuing add debt - -Restric on pmt of divids - -Limit on disposal of certain assets - -Limitations on how borrowed money can be used - -Min working cap requirements + -Maintenance of debt ratio, cash flow coverage and times interest earned ratios + -Providing monthly, quarterly, or annual financial statements to bondholders +

Primary Methods of Increasing Cash Levels (Reducing the Operating Cycle)

- "sell and collect quickly" - speed up cash inflows or slow cash outflows - faster AR collections -Reduced cash outflows through delayed (or deferred) disbursements -combination of current cash inflows and current cash outflows related to bus is the ope cycle (mgr objective to shorten cycle)

Long-Term Financing Advantages

- Decreased Int Rate Risk: for borrower, LT financing locks in an int rate over a long period, reducing the exposure to fluctuations in rates - Increased Capital Availability: Securing LT debt guarantees financing over a long period and reduces the company's exposure to any risk that refinancing might be denied or modified with less favorable terms - lock in LT rate

Long-Term Financing Disadvantages

- Decreased Profitability: higher financing costs reduce profitability - Increased Financing Costs: LT debt generally carries a higher int rate given the longer duration of the financing instruments (next two card)

Short-Term Financing Rates

- GR: classified as current and mature within one year - Tend to be lower than LT rates and presume greater liquidity on the part of the org using ST financing

Long-Term Financing Rates

- GR: classified as non-current and will mature after one year - Tend to be higher than ST rates and presume less liquidity on the part of org using LT financing

Short-Term Financing Disadvantages

- Increased Inherent Risk: int rates may abruptly change, and w shorter maturities, may require greater financing charges than anticipated on future refinancing - Decreased Capital Availability: lender evaluation of creditworthiness may change make financing impossible or less favorable by increase rates and/or less favorable terms - not locking in LT rates

Short-Term Financing Advantages

- Increased Profitability: rapid conversion of op cycle components into cash to meet ST obl carries the potential of increased profitability - Decreased Financing Cost: ST int rates are usually lower than LT int rates given the shorter duration of the financing instruments

Disadvantage of High Cash Levels

- ROA decreases -"negative arbitrage" effect (i.e., int obl > int income from cash reserves) -Increased attractiveness as a takeover target -Investor dissatisfaction with allocation of assets (i.e., failure to pay dividends)

Borrowing Capacity

- amount of money in form of credit or loans that a given lender (bank) is willing to extend/lend to comp -Financial strength and stability (credit rating) and collateral a borrower has available to pledge toward the borrowed amount are considered -If borrow defaults on its oblig, the collateral protect the lender -consider income level (stability) of the borrower, this will be the source of repmts to lender -Both lenders and borrowers have to manage their risk - borrowing capacity is protection for both sides -If a lender thinks that the borrower has no capacity to take on debt, the borrowing capacity is zero and no money will be lent

corp banking arrangements - Line of Credit

- bank loan -revolving loan with a bank, or group of banks, that is up to a specific $ max amount for defined term and is renewable upon the maturity date -Any outstanding bal under the line of credit reduce the future availability of funds that may be drawn by the company under that line -Lines of credit that are drawn represent a loan from banks -comp may also have a seasonal revolving credit facility that allows additional capital availably for a limited time period -Seasonal revolving credit facilities are used by comps during periods of high working capital needs

Accounts Receivable Turnover Formula

- can be used to eval the effectiveness of an entity's credit policy - # of times acomp converts it receivables to cash = Sales (net) / Average Accounts Receivable (Net)

Days Sales in Accounts Receivable Formula

- can be used to eval the effectiveness of an entity's credit policy - how many days it takes to convert credit sales into cash = (Ending Net Accounts Receivable / Net Sales) * Number of Days in the Period

methods to speed collections - Concentration Banking

- characterized by the designation of a single bank as a central depository - advantages: improved ctrls over inflows and outflows of cash, reduced idle balances, improved effectiveness for investments

Electronic funds transfer

- electronic movement of funds from one institution to another - ensure timely pmt - immediate collection

Interest Rate Risk: Lender's Perspective

- if int rate increases, value of fixed debt decreases -For lenders, higher int rate is charged for longer-term debt because likelihood that int rates will change over the period of the loan increases as the term of the loan increases -Higher financing charges compensate the lender for increases int rate risk - lenders recognize their exposure to int rate risk with LT financing and charge a premium to borrower in the form of higher rates

corp banking arrangements - Letter of Credit

- lowers cost of borrowing - third-party guarantee, generally by a bank, of financial obligations incurred by the comp -external credit enhancement used by comp issuing otherwise unsecured debt to enhance its credit or can be required by a creditor to ensure pmt (vendors)

Debt Covenants

- protects borrower's credit rating thus reduces the cost of borrowing -Creditors use debt covenants in lending agreements to protect their interests by limiting/ prohibiting actions of debtors that might negatively affect their positions -Covenants in lending agreement can be pos or neg -pos covenant may require that issuer provides quarterly fin reporting information to the investors -negative covenant may restrict on asset sales for a stipulated time frame -When issuing debt instruments, comp mgmt should consider the potential effect on a firm's solvency, highly restrictive covenants could hinder the comp's basic op decisions

Motives for Holding Cash

- to make routine payments for bus trans, to repay loans and other financing costs, to maintain compensating balances for banks, to prepare for future uncertainties, and prepare for future opportunities

Management of Cash and Cash Equivalents

- too little: risk increases; too much ROA decrease -Factors influencing the levels of cash: volume of collections and timing, volume of disburse and timing, and degree to which idle cash is invested in marketable securities -Businesses use various techniques to max cash bal: managing float, synchronizing cash inflows and outflows, speeding collections and deposits, and mitigating risks with overdraft systems or compensating balances

mgmt of AR - Factoring

- turning over the collection of AR to third-party factor in exchange for a discounted short-term loan -Cash is collected from factor immediately rather than from the customer according to the credit terms

Lockbox Systems

-Expedite cash inflows by having a bank receive pmts from a comp's customers directly via mailboxes to which the bank has access -Pmts that arrive in these mailboxes are deposited into the company's account immediately

methods to speed collections - Expedite Deposits

-Fin mgrs not only must collect credit sales in a timely manner, but also ensure that funds are deposited and credited to their account quickly. - techniques reduce time during which pmts received by firm remain uncollected: EFT, Lockbox Systems

Discounts

-Include discount percentage and period -Offering discounts to customers who pay early may result in faster receivables collection, depending on the terms of the discount and customer's own cash needs and capacity to pay early - the cost can be high

Collection Policy

-Measured by its stringency or laxity in collecting delinquent accounts -balancing act between wanting to collect cash owed quickly versus maintaining positive relationships with customers

methods to speed collections - Payment Discounts

-Offering pmt discounts may influence customers to pay faster and can result in improved cash collections -Discounts foregone represent a higher cost to the customer than a bank loan for similar financing

Mgmt of AR - Credit Policy

-One of the major determinate of demand for a firm's products or services, along with price, product quality, and advertising -established by a committee of senior comp execs. Credit policy variables include: 1. Credit Period 2. Credit Standards 3. Collection Policy 4. Discounts

Specific Motives for holding cash include

-Transaction Motive: comp may hold cash to meet pmts arising from the ord course of bus -Speculative Motive: Cash may be needed to take adv of temp opport -Precautionary Motive: enough cash on hand to maintain a safety cushion to meet unexpected needs "liquidity" (concern of treasurer)

Violation of Debt Covenants

-When violated, debtor is in technical default and creditor can demand repmt of entire principal -Most of the time, concessions are negotiated and real default (opposed to technical default) is avoided -Concessions can result in violated covenants being waived temp or perm -Concessions can also result in a change in int rate or other terms of debt

Short-Term Financing Effect on Working Capital

-classified as current liability and Decreases working capital -extent org uses ST financing is dependent on the amt of current assets it maintains and risk tolerance of mgmt -Shorter term financing strategies require current asset levels to be sufficient to meet short-term obligations

Long-Term Financing Effect on Working Capital

-classified as non-current and not included in calculation of working capital -However, divid, int, and principal repmts all require cash, which can reduce working capital over time -extent to which org uses LT financing is dependent on amount of current assets it maintains and risk tolerance of management -Long term financing increases financial leverage

Credit Period

-length of time buyers are given to pay for purchases -common: 30 days -If policy too long, comp may experience cash shortages -period too short may damage relationships with customers and negatively affect future sales

Credit Standards

-required fin strength of credit customers -Extending credit to only financially strong customers minimizes uncollectible receivables but also limits potential sales -Extending credit to a broader base of customers increases sales, but adds risk in that a greater percentage of receivables are likely to be written off

methods to speed collections - Prompt Billing

Timely billing of charges to credit customers ultimately serves to speed collections

Interest Rate Risk: Borrower's Perspective

borrowers lock themselves into a LT int rate to reduce their exposure to interest rate risk, and pay a premium to do so

methods to speed collections - Customer Screening and Credit Policy

comp can choose to extend credit to more responsible customers, who are more likely to pay bills promptly