Agriculture Reference
In-Depth Information
relate to the major tools and alternatives that Doug Davies should consider in making this
expansion decision.
Debt or equity fi nancing
The next question that Doug had to ask himself was, “What sources are available to provide
the additional funds?” Basically, there are four types of capital:
1.
Short-term loans: one year or less
2.
Intermediate-term loans: one to fi ve years
3.
Long-term loans: more than fi ve years
4.
Equity capital: no due date
Short-term loans
Short-term loans
are generally defi ned as loans for one year or less, and they are used
whenever the requirement for additional funds is temporary. Doug recognized the need for
funds to increase inventory for the spring and summer, when the building business is at its
seasonal peak. Some of these funds would also be needed to support accounts receivable as
inventory is sold to customers. An important characteristic of short-term loans is that they
are usually self-liquidating, that is, they often start a chain reaction process that results in
their repayment:
Loan
=>
inventories
=>
receivables
=>
cash
=>
repay loan
While short-term loans may be made on an unsecured basis to fi rms that are well established,
there is often a requirement for collateral, or for the loan to be secured by some of the fi rm's
assets. Collateral can take many forms, but for short-term loans it most often takes the form
of current assets. Some of the most common kinds of collateral are inventory, accounts
receivable, warehouse receipts, and marketable securities. Also, a personal guarantee of the
loan is often required by the owners of smaller agribusinesses. In other words, the owner or
owners endorse the obligation to repay the debt, and become personally liable if the fi rm is
unable to meet the payment.
Short-term loans may be regular-term loans, with a specifi c amount due at a specifi ed
time, or they may be revolving or line of credit loans. Managers who anticipate a need for
short-term funds often apply for a line of credit in advance of their needs. A
line of credit
is
a commitment by the lender to make available a certain sum of money to the fi rm, usually
for a one-year period and at a specifi ed rate of interest, at whatever time the fi rm needs
the loan. Usually, the loan must be repaid during the operating year of the fi rm.
With a line of credit, a manager is assured of protection in the form of cash that is
available as it is needed; there is also the added advantage of not incurring interest on
the borrowed funds until they are actually used. Lenders who make a line of credit available
to an agribusiness often require that a monthly copy of the fi rm's fi nancial statements
be furnished to them so that they can monitor the fi nancial health of the fi rm. Doug Davies
wanted to avail himself of a line of credit for his short-term cash needs for seasonal
purposes. He did not feel that he would have a problem securing these funds because he
could pledge his inventory and accounts receivable as collateral against any outstanding
loans.
