Principles of Managerial Finance

(Dana P.) #1
CHAPTER 15 Current Liabilities Management 641

short-term, self-liquidating loan
An unsecured short-term loan in
which the use to which the
borrowed money is put provides
the mechanism through which
the loan is repaid.


In Practice


Top managers in a tiny central
Ohio company fret but say nothing
publicly as a giant retailer routinely
waits 120 days to pay its invoices
marked “due in 30 days.” The
credit manager is quiet, partly
because the company depends on
this key account for survival and
partly because “stretching
payables” is the most widespread
unethical practice in corporate
America.
Unlike the retailer above,
e-tailer Amazon, despite its size
and marketing success, pays its
suppliers on time amidst intense
pressures on it to become prof-
itable. Amazon has changed strat-
egy, emphasizing profitability over
growth. In fact, during 2001 it
reported its first profit—1¢ per
share. CFO Warren Jensen,

describing the critical role man-
agement of working capital plays
in the quest for profits, was quoted
in CFOmagazine as saying, “This
isn’t about trying to string our ven-
dors out.” Amazon has negative
net working capital (that is, its cur-
rent liabilities exceed current
assets) but has chosen to employ
just-in-time inventory delivery from
book publishers—not delayed pay-
ments—to reduce the need for
short-term bank loans. One advan-
tage of Amazon’s payables policy
is that suppliers would be likely to
work with Amazon should its cash
position temporarily drop below
that needed to cover payables.
In economic downturns, com-
panies face even greater tempta-
tion to delay payments, and many
do so. Stephen Payne, of REL

Consultancy Group, warns that this
unethical practice “can bite you in
the rear end” as suppliers detect it
and simply jack up prices to
counter the effect. The buyer’s
average payment period repre-
sents its suppliers’ average collec-
tion periods, after all.
Stretching payables is unethi-
cal for two reasons. First, the
buyer is violating the terms of its
trade credit agreement. Second,
the buyer is in effect doing addi-
tional borrowing from its suppliers
without their knowledge or autho-
rization. “Everybody’s doing it” is
never a valid excuse for trying to
add to shareholder wealth through
such blatantly unethical behavior.
Shareholder wealth maximization
is once again seen to be subject to
ethical constraints.

FOCUS ON ETHICS Amazon Stays Ethical to Avoid
Biting the Hands That Feed It

LG3 LG4 15.2 Unsecured Sources of Short-Term Loans


Businesses obtain unsecured short-term loans from two major sources, banks and
commercial paper. Unlike the spontaneous sources of unsecured short-term
financing, bank loans and commercial paper are negotiated and result from
actions taken by the firm’s financial manager. Bank loans are more popular,
because they are available to firms of all sizes; commercial paper tends to be
available only to large firms. In addition, international loans can be used to
finance international transactions.

Bank Loans
Banks are a major source of unsecured short-term loans to businesses. The major
type of loan made by banks to businesses is the short-term, self-liquidating loan.
These loans are intended merely to carry the firm through seasonal peaks in
financing needs that are due primarily to buildups of inventory and accounts
receivable. As inventories and receivables are converted into cash, the funds
needed to retire these loans are generated. In other words, the use to which the
borrowed money is put provides the mechanism through which the loan is
repaid—hence the term self-liquidating. Banks lend unsecured, short-term funds
in three basic ways: through single-payment notes, lines of credit, and revolving
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