Long-Term Loans

Debt Financing

Part II. Sources of Long-Term Funds

Factoring Accounts Receivable

Commercial Paper

Some firms can raise funds in the short run by issuing commercial paper. But commercial paper is backed solely by the issuing firm's promise to pay. For this reason, issuing commercial paper is an option for only the largest and most creditworthy firms.

How does commercial paper work? Corporations issue commercial paper with a certain face value. Companies that buy commercial paper pay less than that value. At the end of a specified period (usually 30 to 90 days, but legally up to 270 days), the issuing company buys back the paper - at the face value. The difference between the price paid and the face value is the buyer's profit.

Commercial paper offers those few corporations able to issue it several advantages. Its cost is usually lower than prevailing interest rates on short-term loans. It also gives the issuing company access to a wide range of lenders, not just financial institutions.

A firm can raise funds rapidly by factoring - selling the firm's accounts receivable. In this process, the purchaser of the receivables, usually a financial institution, is known as the factor. The factor pays some percentage of the full amount of receivables due to the selling firm. The seller gets this money immediately.

Just as firms need short-term funding to cover their short-term expenditures, so they need long-term funding to finance their long-term expenditures on fixed assets. Firms need funds for the buildings and equipment necessary for conducting their business. Companies may seek long-term funds from outside the firm (debt financing), or they may draw on internal financial sources (equity financing).

Long-term borrowing from outside the company - debt financing - is a major component of most firms' long-term financial planning. The two primary sources of such funding are long-term loans and the sale of corporate bonds.

In many respects, a long-term loan is very much like a short-term loan. The major difference is that a long-term loan extends for three to ten years, while short-term loans generally must be paid off in a few years or less. Most corporations get their long-term loans from a commercial bank, usually one with which the firm has developed a long-standing relationship. But credit companies, insurance companies, and pension funds also grant long-term business loans.

Long-term loans are attractive to the borrowing companies for several reasons. First, because the number of parties involved is limited, long-term loans can often be arranged very quickly. Second, the firm need not make a public disclosure of its business plans or the purpose for which it is acquiring the loan. Third, the duration of a long-term loan can easily be matched to the borrower's needs. Finally, if the firm's needs change, long-term loans usually contain clauses making it possible to change the loan's terms.

Long-term loans also have some disadvantages. Borrowers of large sums may have trouble finding lenders to supply the needed funds. Long-term borrowers also may have restrictions placed on them as conditions of the loan. They may have to pledge long-term assets as collateral. And they may have to agree not to take on any more debt until the borrowed funds are repaid.

The interest rate on long-term loans is negotiated between the borrower and the lender. Loans from banks usually have a floating rate that is tied to the prime rate. The prime rate is the interest rate the bank charges its most creditworthy customers. A company that obtains a loan at «one percent above prime» pays an interest rate that is one percentage point higher than the prime rate. This rate may fluctuate because the prime rate itself goes up and down as market conditions change.

Дата добавления: 2015-01-03