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IFT Notes for Level I CFA® Program

R29 Sources of Capital

Part 2

4. Evaluating Short-Term Financing Choices

Since many short-term financing alternatives are available, a company should evaluate these options and create a planned borrowing strategy that will maximize its cost savings.

The objectives of a short-term borrowing strategy for companies are to:

  • Ensure sufficient capacity to handle peak cash needs.
  • Maintain sufficient sources of credit.
  • Ensure rates are cost-effective.

Factors that will influence a company’s short-term borrowing strategies are:

  • Size and creditworthiness: Larger companies have additional and cheaper options as compared to smaller companies. The borrower’s creditworthiness determines the access to and the cost of borrowing.
  • Legal and regulatory considerations: Legal and regulatory constraints on specific industries can restrict how much a company can borrow and under what terms.
  • Sufficient access: Borrowers should adequately diversify and not rely too much on any one lender or any one form of borrowing.
  • Flexibility of borrowing options: Maturities should be managed effectively, there should not be any ‘big’ days when several amounts of loans mature simultaneously.

Borrowing strategies can be active or passive. Passive strategies involve little or no planning. They typically rely on just one source or type of borrowing and routinely rollover the borrowing.

Active strategies involve more planning, reliable forecasting, and comparison pricing. They help avoid the rollover trap. Many active strategies are matching strategies: loans are scheduled to mature when large cash receipts are expected. Doing this allows the company to avoid investing the cash receipts at lower rates than the borrowing costs in the interim.