ONLINE CHAPTERS19- 4c SHORT-TERM BORROWING
For many companies, a primary source of liquidity is access to short-term overdrafts or commercial bills
(unsecured short-term bond issues) programs to provide needed funds. This is especially the case for
companies in seasonal businesses where large amounts of operating capital may be needed for only a few
months of the year. The role of the cash manager in establishing short-term borrowing arrangements is to
ensure that the company has credit facilities sufficient to meet short-term cash requirements. Obviously,
these arrangements should provide maximum flexibility at a minimum cost. Access to credit can be a
major issue for companies in a time of financial crisis. For example, many creditworthy companies in
Australia had difficulty getting the credit they needed as the global financial and credit crisis deepened in
late 2008 and early 2009, even though the Australian government provided guarantees for bank loans and
deposits, for retail and corporate customers. Both bank lending and access to commercial paper markets
were severely constrained for most companies until early 2010, when credit markets began to thaw.
Most short-term borrowing is done on a variable-rate basis, with rates quoted in terms of a base rate
plus a spread. The spread is essentially an adjustment for the relative riskiness and overall creditworthiness
of the borrower. The base rate plus the spread are referred to as the all-in rate.
Typical base rates include the prime rate and LIBOR (London Interbank Offered Rate). The prime
or cash rate is the rate of interest charged by the largest banks on short-term loans to the best business
borrowers. This is usually set relative to a base rate such as the Bank Bill Swap Rate (BBSW) in Australia.
LIBOR is the rate that the most creditworthy international banks that deal in Eurodollars charge on
interbank loans in the international capital markets.
For bank overdrafts or lines of credit, lending agreements may require commitment fees (fees paid for
the bank’s agreement to make money available) and/or compensating balance requirements (minimum
deposit balances that must be maintained by the borrower at the lending bank). These agreements may
also be set up on a multiyear, revolving basis, and may use current assets such as receivables or inventory
as collateral. In any type of bank lending, most of the terms and conditions result from negotiations
between the borrower and the bank.all-in rate
The base rate plus the spread
on a short-term variable rate
loan
prime or cash rate
The rate of interest charged
by the largest banks on
short-term loans to the best
business borrowers
Bank Bill Swap Rate
(BBSW)
This is the average mid-point
of banks’ bid and offer rates in
the bank bill secondary market
in Australia
LIBOR
The London Interbank Offered
Rate. The rate that the most
creditworthy international
banks that deal in Eurodollars
charge on interbank loans
finance in practiceAlthough we consider the issues of credit lines
in a typical’ economic environment in this book,
CFOs become much more concerned about the
use of credit lines when the economy is behaving
uncertainly. The period of the global financial crisis
(2007–2010) tested the importance of lines of credit
for many US companies. Recent research on this
topic by Jose Berrospide and Ralf Meisenzahl of
the Federal Reserve Board has drawn the following
conclusions:
We show that firms use credit line
drawdowns to finance investment,
thereby verifying that credit lines function
as insurance against adverse shocks.The effects of credit line drawdowns
on investment are economically large
and statistically significant. A one
standard deviation increase in the size
of the drawdown is associated with an
11 percent increase in average capital
expenditures (an increase of 0.15 percent
of total assets).
The financial crisis amplified the
effect of drawdowns on investment
significantly. The effect of drawdowns on
investment increases by 40 percent in the
full sample and more than doubles for
financially constrained firms. However, we
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