Introduction to Finance

%
discount
100
%
−
%
dicount
)
365∕(Credit period − discount days)
− 1
In the text example, we have the following:
True effective cost =
(
1 +
2
%
100
%
− 2
%
)
365∕(30− 10)
− 1
= (1.0204)
365∕20
− 1
= 1.446 − 1 = 0.446, or 44.6 percent

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506
C H A PT E R 1 6 Short-Term Business Financing
and farm equipment, and other types of business credit. The Commercial Finance Association 
estimates the total volume of business credit outstanding by the commercial fi nance compan-
ies to be almost $215 billion.
11
The equity position of commercial fi nance companies is greater than that of banks. How-
ever, these organizations do not operate on equity capital alone. Additional long-term capital 
is acquired by selling debenture, or unsecured, bonds. In addition, commercial banks lend a 
large volume of money at wholesale rates to commercial fi nance companies, which, in turn, 
lend it to business borrowers at retail rates. Nonbank fi nancial intermediaries, commercial 
fi rms, and industrial fi rms often fi nd it advantageous to invest their temporary surplus funds 
in the commercial paper of commercial fi nance companies. These sources of short-term funds 
permit the commercial fi nance companies to meet their peak loan demands without having too 
much long-term debt, only part of which would be used during slack lending periods.
When viewing the high interest rates (sometimes as high as 15 to 20 percent) for com-
mercial fi nance company loans, the question may arise: why would a borrower use these 
companies? A business with ample current assets and a highly liquid position may be advised 
to rely on other short-term fi nancing sources. When business is most brisk and growth possib-
ilities most favorable, the need for additional short-term funds becomes pressing, as it is when 
customers are slow in paying their bills and the company needs cash.
A business will, typically, fi rst request an increase in its bank line of credit. Failing this, an 
additional loan from a bank may be secured by pledging inventory or receivables as collateral. 
However, not all banks actively engage in this fi nancial arrangement. Thus, a business may 
have to deal with a commercial fi nance company. Commercial fi nance companies can oper-
ate through a system of branches on a regional or national basis, unhampered by restrictions 
placed on bank branch operations. Therefore, they can acquire the business volume necessary 
to cover overhead and provide the needed diversifi cation of risks for high-risk fi nancing. Sev-
eral bank holding companies have purchased or established commercial fi nance companies to 
take advantage of their special operating characteristics.
Commercial Paper 
CRISIS
A fi nal source of short-term fi nancing is not a specifi c type of lender but the fi nancial 
marketplace itself. Large U.S. corporations of high credit quality can issue or sell