SOURCES AND USES OF FUNDS

DISTINCTION BETWEEN SHORT TERM AND LONG-TERM* FUND

DISTINCTION BETWEEN SHORT TERM AND LONG-TERM* FUND

To attain the company's targets, it must includes sufficient funding of any corporate investment.
Funding sources are, generally speaking, capital raised by issuing new debt and equity, which is
self-generated by the company and capital from outside investors or funders.
In terms of strategy and cash flow, management must seek to align the long-term* or short-
term*
funding mix as closely as possible with the assets* being funded.
SHORT-TERM FINANCING*
Short-term funding* can be adapted for a duration of up to one year to enable companies to pay
primarily for their short-term needs.
Uses of Short-Term Funds
The best way to understand why firms resort to short-term financing is to look into its
operations. Firms
need to access short-term funds for the following reasons:
1. To sustain occasional rise in demand* for its goods and services- The company would need to
acquire more inventories and supplies. Additional manpower will require more funds to devote
to salaries.
2. Payment of short-term obligations- Firms need to satisfy their financial obligations. At times
they have to resort to short-term loans in order to repay other obligations such as the supply
credits and tax liabilities.
3. Funding for short-term projects or programs- Short-term plans and programs are identified
during the annual planning of any firm. Even at that point, the finance manager should already
have an idea of whether there would be sufficient funds or not.
4. Allowance for receivables- It may take some time before a firm is able to collect money that
is owed to them by customers. Before sales are actually converted into cash, the firm has to
supply funding to cover maturing obligations and replenish inventory.
5. Funding for unforeseen events- Such events may be economic such as sharp increase in the
prices of inputs and prime commodities, a natural calamity or anything that may arise as a result
of the firm’s operations like a defective product that negatively affected a customer.

Sources* of Short-Term Funds*

Given here are sources* of short-term funds* for different firms:
1. Supplier’s Credit- As raw materials* and supplies are part of working capital*, the best
sources of these are the suppliers providing credit to business owners. This is the reason why a
good relationship has to be nurtured with suppliers. As much as possible, honor the credit terms.
Some suppliers charge a small interest rate on their deliveries to their customers if not paid on
time.
2. Advances from stockholders- personal funds advanced by a stockholder to a company that
usually requires interest. These usually require little to no interest on advances, especially if the
owner is advancing funds to assist the company in sudden liquidity crisis. This source, however,
is depended on the availability of funds of an individual.
3. Credit cooperatives- provides lending services to its members. Members usually pay
contributions to the cooperative.
4. Banks – provide several loan products catering to different types of needs. It can be short-
term or longterm loans. Some banks also provide credit facilities, not just to big corporations but
also to small and medium enterprises (SME) like government banks* such as the Development*
Bank of the Philippines (DBP)* and Land Bank of the Philippines (LBP).
5. Lending Companies – companies that are dedicated to lending. They usually charge higher
interest than banks, but their credit requirements are more lenient compared to banks.
6. Informal lending sources such as “5/6”- Interest is usually paid per month, and monthly
interest is (6-5)/5 or 20%. Annual interest is actually 20%*12 or 240%. Therefore, this source of
financing should never be considered because you will end up working for the creditor.

The financial instruments* below are used in short term financing* of companies.
• Commercial Paper*
“This is an “unsecured promissory note” on the global* money market*, with a predetermined
maturity of 1 to 364 days or within 1 year. Large corporations issue it to get financing to fulfill
short-term debt obligations.
This is only backed by a commitment made by an issuing bank or company to pay the face sum
on the date of maturity indicated on the note. Only companies with outstanding credit ratings
from legitimate rating departments and agencies would be able to trade their commercial papers
at a fair price because commercial papers are not supported by collateral; thus, it is only backed
by issuer’s integrity. ”
• Asset-backed commercial paper (ABCP)*
“Naturally, ABCP* is a short-term instrument* that matures between 1 and 180 days* from date
of issuance of financial institutions like banks. Other financial assets serve as collateral for this
type of commercial paper*.”
• Promissory Note*
This type of instrument is a kind of negotiable instrument * used by issuer and payee under
which one party (the issuer) makes an unconditional promise or written commitment to pay the
other (the payee) a certain amount of money in certain conditions, either at a specified future
period or on the payee 's request (on demand of the payee*).
• Asset-based Loan*
This form of loan, mostly in the short term**, is backed by the assets of a firm. The usual assets
that are used to collateralize the loan are real estate, accounts receivable (A / R), inventory and
equipment. A single asset category or a combination of assets ( for example, a combination of
Accounts receivables and equipment) may be used as collateral.
• Repurchase Agreements*
“The maturity of these instruments range from one day to less than two weeks, though typically
it is only traded for just one day. There is an agreed fixed price and fixed date as arranged by the
issuer of security and the investor.”

LONG-TERM FINANCING
A long-term* source of funds* or long-term financing is tapped by firms to fund their long-term
capital requirement.
Uses of Long-term funds:
a. Acquisition of machineries and equipment
b. Acquisition of furniture and fixtures
c. Building of a new plant
d. Major upgrade facilities
e. Acquisition of an existing firm
f. To organize a new venture or additional strategic business unit

REMEMBER! Long-term investments have to be financed by long-term sources of funds to minimize

default risk* which means that a firm may not be able to meet maturing obligations. The returns on
long-term* investments may not be realized immediately, and therefore require more patient source of
financing.
Sources of Long-term* Funds
• Equity Financing*
“This involves preferred stocks** and common stocks* which are less volatile in terms of cash
flow commitments*. It does, however, result in a dispersion of shareholding, control and profit.
The cost of equity*is therefore usually higher than the cost of debt-which is, however, a
deductible expense*-and so equity investment will result in a higher threshold rate that can
reduce some decline in the risk of cash flow. ”
• Corporate Bond*
“A corporate bond* is a bond issued by a company to help raise capital to grow and develop its
enterprise. The term is typically attributed to longer-term debt instruments*, with a maturity
date* commonly following at least one year after their issuance date. ”
Some corporate bonds* have an embedded* call right allowing the borrower to repay the debt
before its due date. Many bonds, or convertible bonds, make it possible for creditors to turn the
bond into equity*.
• Capital Notes*
Capital notes* are a type of convertible security* which can be exchanged into shares. This is
the
reason why they are termed as equity vehicles*. Capital notes are similar to bonds, in that they
also have no expiry date or exercise price (thus, the entire fee that the corporation hopes to
obtain is charged when the capital note is released for the future issue of shares).
Capital notes* are often issued in conjunction with a debt-for-equity* exchange restructuring:
instead of selling the shares (which substitute debt) at present, the corporation offers investors
convertible securities capital notes – so the dilution or dispersion of ownership will just happen
at a later period.
• Internally generated funds
Not all profits are distributed to stockholders. Most of the profits are re-invested and used by
companies to finance their needs. Instead of declaring cash dividends, the company can use
internally generated funds for expansion or to finance other types of capital investments.
• Banks
They provide long-term loans which also depends on the type of business needs. For instance, a
5-year to 10-year loan may be granted if the purpose of the loan is construction of an office
building. They provide lower interest rates* than other institutions in the market but they have a
lot of requirements and processes.

DEBT AND EQUITY FINANCING

Choosing between investing in equity and taking out a loan for a company is a struggle for all
entrepreneurs when they need capital to grow a business. A dilemma between opting for a bank
loan to finance your business
operation and looking for a venture capitalist or investor is a very tough decision for the
financial manager.Equity* funding also includes giving an investor more shares of common
stock. With more common stock shares issued and outstanding, the level of ownership of
previous stockholders is being reduced.
“Debt financing* means borrowing money and not sacrificing property. Debt financing* also
has rigid terms or covenants, as well as having to pay interest and principal on set dates. Failure
to meet the debt criteria would have serious repercussions. Debt interest is a deductible expense
when calculating taxable earnings. It means that if the business is profitable the effective interest
cost * is less than the reported interest. Having too much debt would raise the potential cost of
borrowing capital for the company and it will bring risk to the organization.
Consider the advantages and disadvantages of each to determine which type of financing is best
for your business:
▪ Equity financing
If an entrepreneur wants to grow a company but cannot afford the risk to take on debt, an
investor that is willing to finance the operations of the company may seem like the perfect
answer to that. It's capital without the redemption or interest-causing- headache, after all. Yet
the Pesos come with big strings attached: with the venture capitalist or angel investor, you have
to split the profits depending on the predetermined agreement.
Advantages of equity financing*:
➢ Since investors understand that you do not have to pay or return anything back, it's less
expensive than
a loan. It is then a nice choice if you do not want to take the risk of having debt.
➢ Accessing the investor's network can contribute to the business' reputation. • Investors
usually have a long-term plan for their investment and most of them do not seek an instant gain
on their investment.
➢ You 're not going to have to direct income to repay the loan.
➢ You 're going to have more cash available for company expansion.
➢ In the event of bankruptcy, there is no obligation to return the investment.
Disadvantages of equity financing*:
➢ Sometimes, expected returns may be more than the rate you would have paid instead for a
bank loan*
➢ The investor would need the company's ownership and a part of the income. You do not want
to relinquish this kind of power over your company.
➢ You'll need to inform investors before making major (or routine) decisions — and you may
differ with your investors’ decisions arising to conflict.
➢ In the event of disputes with investors, you will need to cash the percentage of your
ownership and permit investors to take over the company without your presence.
➢ Finding the best investor for your business requires time and dedication.

Debt financing**
The banking arrangement or terms that you have with a bank that loans you money is somewhat
different from an investor's loan — it does not demand you to give up a portion of ownership of
your business. But if you're carrying on too much debt, it is a problem that may hinder the
expansion of your firm.
Advantages of debt financing*:
➢ The bank or lending agency (such as the Small Business Administration*) does not have any
influence on your methods of business operations your and it has no any control over the
company.
➢ If the money is paid back, the business agreement ends with it.
➢ Tax free interest on the loan.
➢ there is flexibility of choosing between short-term* or long-term loans*.
➢ Principal* and interest rates* are established statistics that you should prepare and include in
your budget ( for as long as your rate of loan is not variable).
Disadvantages of debt financing*:
➢ Maturity period of your debt must be met which means it should be paid back on time
➢ The owner might struggle to meet the obligations to the bank if the company’s capital
structure has more percentage of debt financing. This will then negatively affect the cash flow
of the company.
➢ When you hold too much debt, prospective investors will see you as a "high risk" – which
would affect your company in the future for it may limit your ability to raise capital through
possible equity funding.
➢ Debt funding will make business susceptible to financial issues in times of difficulty when
profits fall due to fluctuation of sales.
➢ Because of the significant cost of repaying the loan, it may make it hard for the organization
to expand.
➢ Company properties can be retained by the lender as collateral. And the company's owner is
always expected to guarantee the loan's repayment in person.
“Many companies choose the combination of both equity and debt funding to meet their needs
especially when a company decided to expand its operations in the market. A good combination
of the two methods of funding will be much more effective to reduce each of their drawbacks.
The right balance will vary based on the business size, cash flow, income and the amount of
money you need to improve your business.”
For the purpose of identifying the bank* and non-bank institutions* that may be source of
funds*, the roles of the following institutions are reiterated:

Debt financing
Is being done through borrowing, whether short-term or longterm, and it usually comes with
interest. This, together with other charges, is referred to as the cost of borrowing or cost of debt.
Common debt financing arrangements include bank loans, issuance of debt instruments like
bonds, financing from nonbank institutions like lending companies and cooperatives,
assignment of accounts receivable, and selling of notes receivables. In here, there exists a
borrower-lender relationship. In the case of banks and other nonbank institutions, borrowing
entails compliance of certain requirements.
• Commercial Banks*
“Accepting deposits and providing convenience and guarantee to the customers that their money
is secured in their institution are the main purposes of commercial banks. One aspects of the
banks' original intent is to provide safe keeping for their money to customers. When holding
physical cash at home or in a pocket, the possibility of loss due to robbery and injuries is
present, not to mention the loss of future interest income. Customers no longer have to hold
huge quantities of money on hand now that banks can do it for them. In addition, purchases can
be done with checks, debit cards or credit cards.”
“Commercial banks often offer loans that individuals and companies use to buy products or
increase business activities , resulting in more deposited funds finding their way into banks.
These institutions earn money by charging higher rates to loans than what they have to pay to
their depositors and covering of their business operational expenses.”
“Banks often play under-estimated roles as payment agents* within a country and among
nations. In addition to issuing debit cards* that allow account holders* to pay for products with
a card swipe, banks may also organize wire transfers* with other entities. Banks effectively
underwrite* financial transactions by lending their integrity and legitimacy to the transaction; a
check is simply just a promissory note between two individuals, but no merchant will approve it
without a bank 's name and identification on that note. The banks make financial transactions
even more convenient as payment agents;; Credit cards, checks and debit cards are now
typically accepted and allowed in different enterprises so holding huge amount of money is not
needed anymore.

Nonbank Financial Institutions*

These institutions are not banks but they offer similar services as provided by commercial
banks*.
• Savings and Loans*
“Savings and loan* companies, also called S&Ls or thrifts, in many respects emulate banks'
services and operations. The discrepancies between commercial banks and S&Ls are unclear to
most customers. lBy regulation, companies with savings and loans must have 65 percent or
more of their loans in mortgage debt or residential loans, although other types of loans are
permitted.”
“S&Ls* have evolved considerably in reaction to commercial banks' uniqueness. There was a
time when banks would only accept deposits, with references, from people of relatively high
wealth and would not lend to ordinary workers. Savings and loans typically offered lower
borrowing rates and higher interest rates on deposits than commercial banks which are more
appreciated by different entities; However, savings and loans have lower profit because they are
mutually owned. ”
• Credit Unions
“Another substitute to standard commercial banks is the credit unions. Unlike S&Ls, credit
unions
typically pay higher savings rates and lower loan charges relative to commercial banks. Nearly
all the credit unions are structured as non-profit cooperatives. Unlike banks and S&Ls, credit
unions can be chartered at the state or federal level.”
“There is one specific limitation on credit unions, in return for a little additional benefits; not
everyone can access the facilities of credit unions because they are only exclusive to a small
category of members. In the past, this has meant that the only people eligible to join a credit
union were workers of certain businesses, members of certain religions and so on. However, as
to the evolution of the financial markets over the years, this limitation has been gradually
changing. ”

• Shadow Banks*
“It is a group of investment banks**, insurers* and other non-bank financial institutions* that
imitate some of regulated banks' operations, but do not function under the same setting that is
regulated and monitored closely.”In the Philippines, the shadow banking* system cashed a lot of
money into the residential mortgage*market. Insurance companies would purchase mortgage
bonds from investment banks, which would then use the revenue to purchase more mortgages*,
enabling them to issue more mortgages*. Revenues from the mortgage sales are then utilized
more by shadow banks to capitalize more on mortgages.
A lot of financial experts calculated the size of the shadow banking system in the Philippines
and they implied that it had prosper to that of the size of the traditional* Philippine banking
system in the year 2008*. “The complexity of the operations within the shadow banking system
created a lot of issues besides having lack of regulatory and documenting requirements. In
particular, most of them "borrowed short" to "lend long." This means that they were utilizing
short-term sources to fund long-term debt commitments. This left these institutions very
vulnerable to short-term rate* rises, and when those rates increased, many institutions were
forced to scramble to liquidate their properties and assets and make margin calls*.
Furthermore, as these institutions were not part of the formal banking system*, they did not
have access to the same emergency funding facilities*.”
DOCUMENTATION LOAN REQUIREMENTS
“A documentation loan* is a type of loan demanding full details to substantiate income and
asset
statements by a borrower to obtain financing*. The huge percentage of loans are loans related to
secured loans requiring full documents. The borrowers use the documentation given during the
underwriting process to ensure that the funding application is correct and to further evaluate the
conditions of a loan agreement.
In comparison, "No doc*" loans do not involve assessing collaterals or any proof of income. No
doc loans are also classified as "extreme risk" loans, and they can also violate the rules of
regular lending. It is still better to obtain a loan for documentation by presenting the requisite
details on loan for security purposes. ”
Income Verification*
“The most important aspect you would need to provide a creditor to indicate you can repay a
loan is to check your company profits and your proof of income. There are many ways to check
profits, which can have different criteria for each lender. One choice that works with most
borrowers is to supply tax details and audited financial statements for at least 2 years. For
example, send copies of W-2 reports valued over the past two years that document your real
income. Alternatively, if you are self-employed, you would need to include related business
papers of your own business transactions. ”
“Creditors can also consider the employer 's pay-check slips or proof of income. Even so, almost
all lenders would check if for at least two years you have earned income that is approximately
equivalent to your present level of income. yThe ideal outcome is to demonstrate continued jobs
with the same employer with a growing income for two years, or evidences that you maintain
good business operations.”
Asset Verification*
“Creditors will recognize your assets as they verify your financial capability in full. Not
everyone need to learn your "total value" to get your loan prolonged or stretched. And, if you
put any collateral on a loan, with extensive reports, you would need to check the value of that
collateral. The statement provided by the primary lender will represent how much equity you
obtained. It shows the second lender how much he would anticipate to get back if you were ever
to fail on paying the loan and the debtor wanted to reclaim your properties.”
Liens and Liabilities*
“Debtors can't quantify your assets to assess the financial security alone. We must always take
into account the loans and obligations. For instance, if you or your company take out a
mortgage, your mortgage lender may require information whether you have loans to other
lending institutions as well. This will impact your ability to have a new loan on the basis of your
present income. Liabilities can be identified by simply testing the credit. Your credit report
should represent all your debts and liabilities in respect of your assets.
A credit review is done without you having to submit any proof or supporting documents.
Everything you need to know is your Social Security number*, Tax Payer* Identity or Credit
Report number, etc. With your permission, the lender will process the credit check. ”
LOW OR NO DOCUMENTATION LOAN*
“There is also what we call low documentation loan that demands hardly any examination of the
statements when applying for a loan. Documentation loans* allow a borrower to provide proof
of income, proof of assets and other documentation before the underwriting process progresses.
None of these items are needed by low documentation loan. Then, the borrower just needs to put
enough money as a down payment* to get the loan. The borrower will have to consider higher
interest rates and borrowing costs as well as a lower loan-to - value ratio* on an asset, in return
for the relative simplicity of the lending process. ”
General Steps in Loan Application:
• Loan applicant inquires with the loan officer to apply for a loan.
• The loan officer provides the loan applicant* a loan application form* and interviews the
client.
• The loan officer then decides what type of loan product the borrower qualifies in, and then
provides them a list of requirements.
• The applicant then submits the requirements along with the loan application form.
• If collateral is required, the corresponding mortgage documents are made ready.
• The loan officer then forwards the documents to the credit evaluation department.
• The credit evaluation department checks whether the applicant provided the complete
documents.
• Credit investigation is done, and the credit worthiness of the loan applicant is evaluated.
• The credit analyst prepares a recommendation and will present the recommendation before a
loan committee who approves the loan application. The loan committee is generally composed
of top executives from the bank.
• If the loan is approved, then the post-approval requirements will be sent to the loan applicant
for
compliance.
The 5Cs of Credit
Financial institutions or intermediaries need a way to evaluate the credit worthiness of potential
clientsindividuals and firms who apply for credit. This serves as the basic requirement when
applying for a loan.
✓ Character –this refers to an applicant reputation and the enthusiasm of the borrower to meet
his or her
obligations to the lending institutions or entities
✓ Capacity – a customer’s ability to generate cash flows; for a firm, a solid business plan is
needed
✓ Collateral – security pledged for payment of the loan to minimize default risk
✓ Capital – sources of finances* of the borrower
✓ Condition* – present conditions of the market, economy and even politics
DUTIES OF THE BORROWER TO CREDITORS
➢ Pay the creditors based on the payment schedule agreed upon. If you cannot pay on time,
notify the
creditors ahead of time.
➢ Provide the collaterals as agreed upon in the loan negotiation with proper documentation, if
necessary
and if applicable (e.g. annotation of the TCT or CCT). Ensure that these collaterals are in the
physical
condition perceived by the creditors in determining the loanable value of the loans.
➢ Comply with the provisions of loan covenant such as maintaining certain liquidity and
leverage ratios.
These conditions are supposed to benefit the borrower so that his company will not be over-
exposed to
borrowing or he will monitor the liquidity position on a more regular basis.
➢ Notify the creditor if the company is acquiring another company or the company is now the
subject of
acquisition. The interest of creditors may be jeopardized if new owners take over the company
or if the
company is going to acquire another company.
➢ Do not default on the loans as much as possible. Aside from the creditors, there may be other
parties
such as the guarantors of the loan who will be put at a disadvantage if the borrower defaults

Equity Financing,
On the other hand, refers to the sale of ownership interest, most often represented by shares, to
raise fund for business purposes. To compensate for the use of funds from equity financing,
dividends or profits shares has declared, set aside, and paid by the business. Common Equity
financing arrangements include funds raise by the entrepreneur or business owner from friends
and family, capital infusion through direct sale of shares or through initial public offerings, and
financing by private companies. In here, there exists an investee-investor relationship.
 Short-term financing is debt scheduled to pay within a year while long-term financing is debt
paid in more than a year.

What are the sources of funds?

The most common sources of funds include banks, cooperatives, and commercial Finance
companies. Cooperatives and commercial finance companies are example of nonbank
institutions.
⮚ Bank- Supervised and regulated by the Bangko Sentral ng Pilipinas (BSP), an
establishment for the deposit, custody, and issue of money for making loans and discounts, and
for making easier the exchange of funds. In the Philippines, banks include universal and
commercial banks, thrift banks, and rural and cooperative banks.
⮚ Credit Cooperatives- With the primary objective of helping improve the quality of life of
its members. One of its aims is to provide goods and services to its members to enable them to
attain increased income, savings, investments, productivity and purchasing power, and promote
among themselves equitable distribution of net surplus through maximum utilization of
economies of scale, cost-sharing and risk-sharing. In particular, credit cooperatives promote and
undertake savings and lending services among its members. It generates a common pool of funds
in order to provide financial assistance to its members for productive and provident purposes. All
cooperatives regulated and supervised by the Cooperative Development Authority (CDA). The
BSP, in coordination with the CDA, shall prescribe the appropriate prudential rules and
regulations applicable to the financial service cooperatives.
⮚ Commercial finance companies- they are organizations without a bank charter that
advances funds to businesses by discounting notes receivable, making loans secured by
mortgage, or financing deferred-payment sales of commercial and industrial equipment.
Loan Applications Requirements Loan Application process
Demographics –includes the name or business  Receipt of application form and
name, birthdate, address, SSS no., TIN no., required documents;
phone no., and other identifying information
such as valid government-issued identification
cards
Income or revenue refers to current personal  Verification of information in the
income and employer, employment and salary application form and required
history, and business revenue, if there is documents may include interview;
already an existing business.
Assets and Liabilities-applicants may ask to • Checking credit history
disclose their checking savings and investment
accounts and their outstanding loans and credit • Writing credit report with
cards, if there are any. appropriate recommendations
Contact or references-require identification • Documenting final decision
and contact information of existing employers,
previous employers, or even nearest relative • If approved, final documents signoff
not living with (interest rate and other terms) and loan
the identified contact release
Attest and authorization require affixing  If rejected, rejection letter
applicant’s signature on the credit sent to applicant
application stating that everything on the
application is true and correct and authorizing
the lender to verify the information provided
with the identified contacts and references.
The credit department evaluates on the basis of
Character, Capacity, collateral, capital and
conditions or 5C’s of credit

Note: Loan application requirements and process vary among banks, credit cooperatives and
commercial finance companies.

Direction: Copy the process questions below in your notebook and answer directly.
1. In loan application, when is a co-maker required?
2. What is the importance of affixing applicant’s signature on the loan application?
3. Enumerate the five C’s of credit and describe each.