Various sources of short-term finance - Assignment Example

?Table of Contents Introduction……………………………………………………………………………….. 02 Sources of Short-term Finance...…………………………………………………………… 02 a) Trade Credit…………… ……….………………………………………………. 02 b) Bank Credit…...…………………………………………………………………. 02 a) Customer’s Advances…. ……….………………………………………………. 03 b) Loan from Cooperative Banks.………………………………………………….. 03 Comparison of Working Capital Performance……..………..…………………………….. 03 Liquidity Ratio………………………………………..……………………………………. 04 Efficiency Ratio……………………………………………………………………………. 05 a) Debtor Days…………….……….………………………………………………. 06 b) Creditor Days……………………………………………………………………. 06 c) Stock Turnover Days….………………………………………………………… 06 Conclusion…………………………………………………………………………………. 07 References…………………………………………………………………………………. 07 Introduction Short-term finances provide flexibility to the business concerns to meet their short-term obligations. These short-term obligations arise as a result of a need to finance the current assets. In other words, working capital requirements are fulfilled by these short-term finance sources. This article aims at discussing various sources of short-term finance that are available to the businesses followed by the illustrations regarding liquidity and financial ratios in order to compare the performance of two entities of a similar industry to check how they manage their working capital requirements. Sources of Short Term Finance There are mainly various kinds of short-term finance sources available to the business entities. Four of those short-term sources are discussed below. Trade Credit Trade credit is a conventional source of short-term finance such that the traders and manufacturers are facilitated by their suppliers to purchase the raw material on credit. The amount of credit is not provided in the form of cash rather the goods are supplied by the suppliers to the manufacturers or traders with facility to pay for those goods after a certain time period generally ranging from 30 to 90 days. Bank Credit Banks also provide the short term credit facility to their customers especially to the business with the availability of funds in the form cash. Normally banks offer different kinds of credit facilities including loans, overdrafts, cash credit and discounting of short-term bills. These facilities mainly differ in terms of interest rates, repayment mechanisms, credit limits, etc. Customer’s Advances At times, when the goods are quite costly or they are to be delivered in bulk and large quantities, the customers are asked by the companies to at least pay some amount in the form of advances. These advance payments are used by the companies to meet their short-term obligations. Generally, the customers do not feel any hesitation in providing advances to the customers when they are aware of the fact that those goods would require some time to be delivered and the goods are also not available easily elsewhere. Loans from Cooperative Banks Cooperative banks are created at the district, community levels such that these banks offer credit facilities to the business entities. They offer better credit facilities as compared to the commercial banks in terms of interest rates and the repayment of the credit. However, those business concerns are obliged to become the members of those communities in order to avail the credit facilities provided by these cooperative banks. Comparison of Working Capital Performance For the purpose of evaluating the short-term finance sources and working capital performance, two companies are selected for this purpose. Those companies are St. Jude Medical (NYSE:STJ) and Medtronic Inc. (NYSE:MDT). The sector, that these companies belong to, is the Healthcare Sector with Medical Appliance and Equipment Industry. St. Jude Medical St. Jude Medical is currently financing its short-term obligations through trade credit and the bank credit as per the financial statements for the year ended 2010. Medtronic Inc. Medtronic Inc. also meets its short term finance requirements with both trade credit and the bank credit. In the balance sheet, trade credit and bank credit are represented by accounts payable and short-term borrowings as on 2010. Liquidity Ratios Liquidity Ratios   STJ MDT         Current Ratio Current Assets 2912 2.86 9839 1.92   Current Liabilities 1017 5121           Quick Ratio Current Assets - Inventories 2912 – 667 2.21 9839 – 1481 1.89   Current Liabilities 1017   5121   The above table presents the liquidity position of St. Jude Medical and Medtronic Inc. By taking a glimpse on the overall liquidity position of both the companies, it can be observed that St. Jude Medical is having a good liquidity position as compared to Medtronic Inc. If the liquidity of St. Jude Medical is closely observed, the company has considerable edge on its competitor in terms of both current ratio and quick ratio. St. Jude Medical is maintaining a healthy current ratio of 2.86 than that of Medtronic Inc. which is quite low with the figure of 1.92. If the impact of inventory is eliminated from the liquidity position of both the companies, the quick ratio of St. Jude Medical is still quite better than that of Medtronic. With the quick ratio of 2.21, St. Jude Medical is leading as Medtronic hardly managed to maintain a quick ratio of 1.89. In simpler words, it can be concluded that St. Jude Medical is effectively managing its liquidity position and having more than double current assets to finance its current liabilities. However, Medtronic is also heading to manage a better liquidity position and reaching to cover its current liabilities with the currents assets by twice of the amount. Efficiency Ratios Efficiency Ratios   STJ  MDT          Debtor Days Accounts Receivable x 365 1331 x 365 94 3335 x 365 77   Sales 5164 15817           Creditor Days Accounts Payable x x365 297 x 365 77 420 x 365 40   Purchases 1410 3812           Stock Turnover Days Inventories x 365 667 x 365 173 1481 x 365 142   Cost of Goods Sold 1410   3812   As far as the efficiency ratios of both the companies are concerned, it can observed that St. Jude Medical is consuming more days in all three respects with that of Medtronic Inc. Overall it can be a policy of the company to manage its short-term finance in any manner that fulfills its strategic financial requirements. However, if both the companies are critically compared, it is quite obvious to state that St. Jude Medical takes more time in both the receipts and the payments. Medtronic Inc. on the other hand has the policy of consuming lesser days in the same respect. Debtor Days Debtor days of Medtronic Inc. are 77 days lower than that St. Jude Inc. which is 94 days. It means that the Medtronic Inc is receiving the payment in respect of sales earlier than St. Jude Medical. This high number of debtor days also increases the likelihood of bad debts. In this way, Medtronic Inc. is managing its receivables in a better way to reduce the likelihood of bad debts than that of St. Jude Medical. Creditor Days Creditor Days of Medtronic Inc. is also less than that of St. Jude Medical such that Medtronic is paying its current liabilities in around 40 days. On the other hand, St. Jude Medical takes around 77 days which is near to twice the number of days that Medtronic Inc takes for its payments. Ratio is favorable for St. Jude Medical in such a manner that St. Jude Medical keeps the cash for 77 days and then pays it off. However, Medtronic Inc. pays its short term liabilities in just 40 days which means that the company is unable to use that cash elsewhere. This is how St. Jude Medical has an edge over Medtronic Inc. Stock Turnover Days Stock Turnover days reflect that how quickly the company is moving its inventories after its purchasing till selling. In this regard, Medtronic Inc. takes around 142 days to make a turnover if inventories, whereas St. Jude Medical takes long time for its inventory turnover and takes around 173 days to move the goods between purchasing and selling. In this way, the likelihood of obsolescence for Medtronic is quite lower than that of St. Jude Medical. Conclusion It can be concluded that both the companies are performing well according to their policies, such that St. Jude Medical has slight edge in terms of its liquidity position, whereas Medtronic Inc. leads over St. Jude Medical in terms of efficiency ratios. Overall, the performance of both the companies seems to be satisfactory. References Baker, H. Kent . and Martin, Gerald S., 2011.Capital Structure and Corporate Financing Decisions: Theory, Evidence, and Practice. New York: John Wiley & Sons. Berk, Jonathan B. and DeMarzo. Peter M., 2010. Corporate finance. 2nd ed. New York: Prentice Hall. Bierman, Harold., 2003. The capital structure decision. New York: Springer. Brigham, Eugene F. and Ehrhardt, Michael C., 2008. Financial management: theory and practice. 12th ed. New York: Cengage Learning. Medtronic, 2010.Medtronic Annual Report 2010. [online] Available at: http://216.139.227.101/interactive/mdc2010/ [29 February 2012] St. Jude Medical, Inc. Common S (STJ). [online] Available at: http://finance.yahoo.com/q/pr?s=STJ+Profile [29 February 2012] Read More