- Another important aspect of short-term
financial management is obtaining short-term financing.
You remember the case of Toys R Us
with a variable seasonal cash flow pattern?
Low cash in October after a big inventory build up?
And then a large cash balance in January
after the holiday season sales and cash collections?
Because of the seasonal up and down fluctuation in cash,
sometimes Toys R Us needs to borrow money in the short-term.
Well, there are several ways to obtain
these short-term loans.
One way is just a straightforward short-term bank loan.
Go to the bank, ask for a loan and promise the bank
that you'll repay the loan in a couple of months.
The best way to get this type of short-term loan,
is to provide the bank with a carefully constructed
short-term cash budget.
The cash budget should show the need for the money,
but also the existence of subsequent surplus cash,
with which to repay the loan.
Now another way to obtain short-term financing,
is to arrange all of this in advance,
say a year or two in advance by obtaining a line of credit.
You go to the bank with a cash budget and you say,
"My business is a seasonal one, over the next two years,
I will be needing short-term cash from time to time.
Let's make the loan arrangements now."
If the bank judges your cash budget to be acceptable,
and if you can offer good collateral for the loans,
such as granting the bank the right to claim your inventory
if you don't repay the loans,
and if the bank trusts your character,
then you can be pre-approved for these periodic loans.
This is called a line of credit.
Many, many companies have pre-approved lines of credit.
For example, in the 2017 annual report of McDonald's,
you can read about the company's $2.5 billion
pre-approved line of credit.
That means that anytime McDonald's needs to borrow
any amount up to $2.5 billion,
they're already approved for it.
Now they pay a little fee for this credit,
but the arrangement provides the company with
nice financial flexibility and predictability.
If you are a very credit worthy company,
a company such as General Electric or IBM,
you can borrow money in the commercial paper market.
Commercial paper is an IOU a piece of paper.
General Electric writes something
like the following on the IOU.
"Please give us $100 million now, and we promise
to pay you back in 30 days or 60 days."
These IOU's are purchased by large investors
or by financial institutions or dealers.
These commercial paper IOU,
circulate in what is called the money market.
The interest rate on these short-term loans
is very, very low.
As of September 2018, the annual interest rate
on these commercial paper loans was about 2%.
As evidenced by these low interest rates,
these commercial paper IOUs are issued
only by very credit worthy companies.
By comparison, you and I are paying 12%
and up on our credit card loans.
Commercial paper is a way for credit worthy companies
to get temporary financing at very low interest rates.
Obtaining short-term financing is a very important part
of short-term financial management.