Accounting Business Reporting for Decision Making

CHAPTER 13 Financing the business 543

Bank overdrafts

An overdraft is normally a loan facility attached to a current (cheque) account. The loan is drawn down

only as required, when cheques written on the account exceed positive balances. The intention of over-

draft finance is that the balance in the account will fluctuate between being positive and negative from

day to day, as cash flows into and out of the entity. The reality check below illustrates National Australia

Bank’s (NAB) overdraft facility for business entities.

REALITY CHECK

NAB and overdraft facilities

NAB provides simple solutions to fluctuating cash flows which helps manage an entity’s day-to-day

business expenses with the ability to draw up to the approved facility limit when the business requires

funds. No set regular payments are required. There are different overdraft facilities available depending

on type of business entity and use. For example, NAB offers a NAB Farm Management Account Over-

draft Facility to help manage seasonal cash flow for farmers. It also offers a NAB Business Overdraft to

help manage cash flow and expenses.

Source: National Australia Bank 2013, NAB Farmer’s Choice Package, http://www.nab.com.au.

Commercial bills and promissory notes

Commercial bills and promissory notes are discount securities. That is, the borrower receives funds less

than the face value, with the face value repaid at maturity. The difference between the funds received by

the borrower and the funds eventually repaid to the lender represents interest and fees. The price of bills

is calculated using the compound interest formula, manipulated so that the PV is the unknown factor as

in the equation below.

PV =

FV

(1 + i)

where PV = the price of the bill or funds lent

FV = the face value of the bill

i = the interest rate for the period of the bill

Thus, a $100 000 180-day bill funded to yield 6 per cent per annum would be priced at $97 126.04. To

arrive at this value, the nominal annual interest rate of 6 per cent is first reduced to the rate for a 180-day

period, that is,

180

×0.06 = 0.029 59.

365

Then,

PV =

100 000

1.029 59

= $97 126.04

There are normally three parties to the issue of a bank-accepted commercial bill (BAB). An entity

(borrower) wanting to access the bill market normally approaches the bank and makes a request. The

bank (e.g. the NAB) draws up a bill and then finds an investor (the ‘discounter’, party two) to fund the

loan. The bank then ‘accepts’ the bill, which means it guarantees that the bill will be honoured at matu-

rity. The bank assumes the credit risk on the bill in return for a fee and becomes the ‘acceptor’ — party

three.

Promissory notes (PNs) are similar to BABs, but they are not endorsed by an acceptor. The borrower

is the only party that is responsible for the repayment of the debt. As there is no other party involved in

guaranteeing repayment, the raising of finance by means of PNs tends to be restricted to larger entities

with good reputations and excellent credit ratings.