Current Liabilities Management

Learning Goals

LG 1: Review accounts payable, the key components of credit terms, and the procedures for analyzing those terms.
LG 2: Understand the effects of stretching accounts payable on their cost and the use of accruals.
LG 3: Describe interest rates and the basic types of unsecured bank sources of short-term loans.
LG 4: Discuss the basic features of commercial paper and the key aspects of international short-term loans.
LG 5: Explain the characteristics of secured short-term loans and the use of accounts receivable as short-term loan collateral.
LG 6: Describe the various ways in which inventory can be used as short-term loan collateral.

Spontaneous liabilities arise from normal business operations and comprise mainly:

Accounts Payable: A significant source of unsecured short-term financing, recognized as trade credit, provided by suppliers.
Accruals: Liabilities incurred for services received for which payment is pending (e.g., wages and taxes).

Proper management of accounts payable is crucial as it impacts a firm's liquidity:

Trade Credit: Essential for the survival of small firms, contingent on effective accounts payable management.
Cash Conversion Cycle: Average payment period is a key part, showing the time from material purchase to payment.

In 2019, Brown-Forman Corporation reported:

Payment Timing: Firms should aim to pay on the last day permissible under supplier credit terms.
Taking Discounts: Delay payments until the last possible day of the discount to maximize cash flow.

For a $1,000 purchase under terms 2/10 net 30, the savings by taking the discount would be:

The implied interest for delaying payment can be calculated by:

Unsecured loans can be obtained from two major sources:

Banks
Commercial Paper - Short-term, unsecured promissory notes issued primarily by large firms.

Key features of bank loans include:

Types: Self-liquidating, single payment notes, lines of credit, revolving credit.
Interest Rates: Relationships with prime rates, may be fixed or variable.
Computing Interest: Differences in methods (paid at maturity, paid in advance affect effective annual rates).

For a one-year loan of $10,000 at an annual rate of 10%:

Secured loans require collateral and typically have lower rates than unsecured loans:

Collateral: Liquid current assets like accounts receivable and inventory.
Pledging Accounts Receivable: Can secure loans, where a lender evaluates the accounts receivable to determine the collateral value.
Factoring: Selling accounts receivable at a discount for immediate cash.

Inventory can serve as collateral similarly through various arrangements:

Trust Receipt Loans: Advances against inventory based on immediate repayment after each sale.
Warehouse Receipt Loans: Loans secured with inventory controlled by a third party.

LG 1: Accounts payable is a major spontaneous financing source.
LG 2: Stretching accounts payable decreases cost of discounts.
LG 3: Unsecured short-term loans are influenced by prime rates.
LG 4: Commercial papers expose firms to unique risks in international transactions.
LG 5: Secured loans require collateral, are often more costly, but offer lower risk to lenders.
LG 6: Inventory can be used as collateral through multiple financing methods.