Corporate Cash Management and Short-Term Financing Strategies

Compensating Balances

Compensating balances are deposits a firm maintains with a bank in low-interest or non-interest-bearing accounts, typically ranging from 2% to 5% of the credit amount used. By leaving these funds with the bank, the firm increases the effective interest earned by the bank on the line of credit.

Secured Loans

Security for short-term loans usually consists of accounts receivable or inventories.

Accounts Receivable Financing

Receivables are either assigned or factored:

• Assignment: The lender holds a lien on the receivables and retains recourse to the borrower.
• Factoring: Involves the sale of accounts receivable; the factor collects the payments and assumes the full risk of default.

Inventory Loans

An inventory loan uses inventory as collateral. Common types include:

• Blanket inventory lien: Grants the lender a lien against all of the borrower’s inventories.
• Trust receipt: The borrower holds the inventory in trust for the lender, documented by a trust receipt.
• Field warehouse financing: A public warehouse company supervises the inventory on behalf of the lender.

Other Financing Sources

Commercial paper: Short-term notes issued by large, highly rated firms with maturities up to 270 days. The interest rate is often lower than the prime rate charged for direct bank loans.

Reasons for Holding Cash

Speculative and Precautionary Motives

The speculative motive is the need to hold cash to capitalize on opportunities, such as bargain purchases, attractive interest rates, or favorable exchange rate fluctuations. Reserve borrowing ability and marketable securities are often used to satisfy these needs.

The precautionary motive is the need for a safety supply to act as a financial reserve.

Transactions Motive

Transaction-related needs arise from the normal disbursement and collection activities of the firm. Cash disbursements include the payment of wages, salaries, trade debts, taxes, and dividends.