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TOPIC 10: INTERMEDIATE TERM FINANCING (1. Term Loan (Sources (Loan…
TOPIC 10: INTERMEDIATE TERM FINANCING
Intermediate-term sources of finance
Definition
Intermediate sources of finance are
financial instruments
with
obligations to pay
between
1 to 5 years
Types
Term Loan
Hire Purchase
Leasing
3. Leasing
Definition
Firm obtains
use of fixed assets
and paid with contractual, periodic payments.
Lease agreement
binds the
lessee
to make
periodic payments
to the
lessor
.
Types of leases
Operating lease (photocopy)
A contractual arrangement whereby the lessee makes periodic payments to the lessor for use of asset
Lease period
is
shorter
than useful life of the asset
Lease is
cancellable
by the lessee
Lessor bears risks and rewards of ownership
Financial lease (specialised machinery)
A contractual arrangement whereby the lessee makes periodic payments to the lessor for use of asset
Lease period
is
longer
than operating lease
Bargain-purchase option
Lease in
non-cancellable
(obligates the lessee to make payments over predefined period of time
Lessee bears risks and rewards of ownership
Types of
lease agreements
Direct lease
Lessor owns and acquires ownership
2.Sales and leaseback agreement
Lessee
sells asset for cash
to a lessor and
leases back the asset
Leverage lease (eg exp assets)
Involves
3rd party lenders
(Lessor supplies a percentage of cost of asset while 3rd party supplies the balance)
Other features
Conserves working capital
No restrictive provisions
Prohibit improvements on leased asset
4. Operating lease
Lessor bears burden of obsolescence
Could lease an asset
while awaiting to buy newer models
Could lease for
temporary use
during
peak periods to meet demand
5. Financial lease
Lessee continues to pay for obsolete assets if non-cancellable
Financing costs
Lease rentals, administrative fees, legal costs (stamp/legal fees)
1. Term Loan
Definition
Loan which is
directly negotiated
with the lender that can be
used for a variety of purposes
.
Terms and conditions
can vary from one loan to another.
Sources
Loan Syndicate
A
group
of lenders who loan a very large amount of loan to a
single borrower
and
share risks
among themselves.
Finance companies
Commercial banks
Insurance companies
Government bodies
Cheap source
of financing for
SMEs
Classification
of term loans
Security (secured/unsecured)
Generally
secured
with an asset
where the loan amount is
less than asset value
Lender has
legal claim
on pledged asset if payment is default by borrower
Payment of interest (fixed/variable)
Fixed
interest rate:
total
interest expense is
known in advance
over
entire life
of loan
Variable
interest rate: Interest rate is
adjusted periodically
based on
specified benchmark
(eg Prime rate)
Payment frequency
Payment of principal (amortized/balloon)
Fully amortized loan
is repaid in
equal periodic installments
which includes interest and principal
Partially amortized loan
involve a
large final repayment of principal
called
balloon
or
bullet
payment at
maturity date
Factors influencing terms and conditions
of loan
Credit worthiness
Financial standing of borrower
Purpose of loan
Riskiness of project
Type of lender
Insurance companies provide
longer term loans
and demand a
higher interest rate
to compensate for their
higher risk
Other features
Negotiability
All terms of loan can be
negotiated
Speed and flexibility
Cheaper financing costs
(as compared to leasing)
Restrictive provisions
Restrictive provisions
Asset control
Require a
minimum level of net working capital
(prevent insolvency) and
constrain in dealing with fixed assets
Liabilities control
Consult lender first before borrowing from others
Cash flow control
Limit cash outlays
Management control
Controls who runs the company
Financing costs
Interest cost
annual/semi-annual/quarterly/monthly rest
Legal and other costs
stamp fees, professional fees, miscellaneous fees, legal fees
2. Hire purchase
Definition
Contractual arrangement
where the hirer agrees to pay a
downpayment
and a
series of monthly installments
for hiring an asset. At the end, he has the
option
to purchase.
Sources
Finance companies
Leasing companies
Retailers
General characteristics
Terms
How much downpayment
Duration
Life of HP
Provisions for early repayment
Fixed installments and dates
Repossession of assets
Other features
of HP
Conserves working capital
Fixed interest rate commitment
Fast speed
Hirer obtains ownership of asset upon last installment
Financing costs
Interest rate is
fixed
and charged on
flat basis
(principal is not reduced)
EIR will be
higher
than the stated interest because stated interest is charged on
full principal amount
for the
entire period