Question

Ray has asked you to review the company's (SPP) short-term financing policies. To assist you getting started, he has prepared some questions that will give Ray a better idea of the company's short-term financing policies. a. What is short-term credit, and what are the major sources of credit? b Is there a cost to accrued liabilities? Fully explain your rationale. c. What control do company's have over accrued liabilities? d. SPP is considering using secured short-term financing. What is a secured loan? What types of current assets can be used to secure the loans? e. What are the differences between pledging receivables and factoring receivables?

Answer 1

a). Short term credit

     A short term credit/loan is a type of loan that is obtained to support a temporary personal or business capital need. As it is a type of credit, it involves a borrowed capital amount and interest that needs to be returned or paid back at a given due date, which is usually within a year from getting the loan.

Sources of short term credit/loan: the ten main sources of short-term fund. The sources are: 1. Indigenous Bankers 2. Trade Credit   3. Instalment Credit 4. Advances 5. Factoring 6. Accrued Expenses 7. Deferred Incomes 8. Commercial Paper 9. Commercial Banks 10. Public Deposits.

b). Accrued Liability

•          An accrued liability is an expense that a business has incurred but has not yet paid. A company can accrue liabilities for any number of obligations, and the accruals can be recorded as either short-term or long-term liabilities on a company's balance sheet. Accrued liabilities only exist when using an accrual method of accounting.
• Depending on the type of liability, there is a cost for such accrued liability. It may be in the form of fines, penalties, interest, other kind of compensations for delay etc.
• The other party, to whom such liability was accrued, has to suffer the late receipt of their dues. So, they deserve some premium over their consideration and it may be in the form of interest etc.

c). Controls

    i). Knowledge of events or transactions that occurred during a period, but will not be paid until a subsequent period, is necessary to identify any missing accruals. Also, before closing out a period, review of expenses compared to prior periods or budgets can help identify if there are any missing accruals.

ii). The typical journal entry for recording an accrued expense would be a debit to an expense account and a credit to an accrued liability account. This entry ensures that you have properly recorded the expense and liability in the period in which the expense has occurred. When you finally make the payment for the accrual, you will relieve the accrued liability by debiting the accrued liability account and crediting cash.

d). Secured loan:

   Secured loans are loans that are backed by an asset, like a house in the case of a mortgage loan or a car with an auto loan. This asset is collateral for the loan. When you agree to the loan, you agree that the lender can repossess the collateral if you don't repay the loan as agreed.

Assets (short term) that can be used to secure loan:

   Blanket lien, UCC lien, Business or personal real estate, Home equity, Business property like machinery or specialized equipment, Business or personal vehicle, Accounts receivable, Inventory, Insurance policies, Investment accounts, Paper investments, Business savings accounts, Such valuables as fine art, jewellery or collectibles

e). Difference between pledging and factoring receivables:

   Pledging of Receivables: Pledging is an agreement where accounts receivable are used as collateral for loan. If receivables are pledged, the lender has recourse against both the original buyer of the goods and the borrower.

Factoring of Receivables: is the sale of an asset - your invoice. The sale of your invoices to a third party - known as a Factor - eliminates the sale-to-collection business cycle of waiting for payment. A factor will purchase your invoices for up to 90% of the total amount. When receivables are factored, they are generally sold, and the buyer (lender) has no recourse to the borrower.