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Unsecured Credit

See Also:
Debits and Credits
Credit Letter
Direct Tax
Credit Memorandum (memo)

Unsecured Credit Definition

Define unsecured credit as credit not collateralized by an asset. It is a common form of credit used for business. Furthermore, an unsecured credit line comes in many forms, including the following:

Though it may go unmentioned, many businesses use it to successfully finance any of their operations.

Unsecured Credit Meaning

Unsecured credit means credit which, when unpaid, cannot be reclaimed through the seizure of an asset. This is important to note because unsecured credit facilities may be confused with secured credit. Though lenders have other methods to regain the value of the credit they offered (such as a court decree saying the lendee must repay the lendor), there is no asset promised by the receiver of the credit.

On a small scale, unsecured credit loans are more simple to acquire than secured credit. For example, credit cards are the easiest method of credit to acquire outside of the financing of “friends, family, and fools”.

On a large scale, an unsecured credit agreement is fairly difficult to acquire. The example of this would be mezzanine debt financing: mezzanine financing is virtually as difficult to acquire as venture capital. In this situation, companies generally use an unsecured credit facility when they can not receive secured credit. This situation occurs when the company can not meet the requirements or obligations of the secured credit lender or prefer to keep their assets free of obligation.

The business owner makes the final decision on whether secured or unsecured credit is the best decision. A general rule of thumb would be that if the company has more to lose by collateralizing an asset then not receiving the financing, unsecured credit may be their best option. consult a trained CFO to find the best option for your business.

Unsecured Credit Example

For example, Karl is an entrepreneur who has started a company which manufactures precision electronics for the military. Because Karl makes each item to changing specifications, Karl must keep a lot of supplies on hand. He must have a strong base of credit to cope with his customer’s changing demands.

Karl has recently outgrown his current lines of credit. To make matters more complicated, he already promised almost all of his assets as collateral for other loans. With no option left, Karl must find an unsecured credit provider. He knows that credit cards will surely not be able to support his needs. He sees mezzanine debt financing as the only option.

After consulting with a trained CFO, Karl realizes that his company will actually lose profit by receiving the funding. The CFO clearly spelled this out in the financial analysis he provided. It seems the best option is for Karl to grow a little slower. Though he will have to deny some customers, it will ultimately result in a stronger business. Going forward, Karl’s company will be financed by free cash flow. Though Karl does not feel like as much of a “high roller”, he is happy that he made the prudent decision.

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Trade Finance

See Also:
Trade Credit
Trade Account
Exchange Traded Funds
Currency Exchange Rates
Currency Swap

Trade Finance Definition

Trade Finance is the movement of assets, transactions, or investments overseas into other markets. To ensure the safety of a purchaser or seller trade finance, banks often provide a needed service to make the transactions as meaningful and as safe as possible.

Trade Finance Meaning

Many transactions among a buyer and a seller result in a prepayment or purchase on credit. This, of course, depends on the terms of the sale. These activities are often more risky for a buyer (importer) or a seller (exporter) because of the international arena in which they operate.

Finance methods often include a bank in transactions to reduce the risk. For example, if a buyer purchases goods on credit, then the seller may want to reduce its overall risk in the receipt of payment by using a trade finance bank. The bank would take part in the transaction by putting up a contract. Whereas, the bank will pay the seller and leave the buyer to pay the bank for the transaction of the goods. If a prepayment occurs, banks can assist in the documentation of the goods to be shipped. This ensures that the buyer is actually purchasing the goods it has paid for.

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Trade Credit

See Also:
5 Cs of Credit
Credit Sales
Standard Chart of Accounts
Income Statement
Free Cash Flow

Trade Credit Definition

The trade credit definition refers to postponing payment for goods or services received. Another trade credit definition is buying goods on credit, or extending credit to customers. It is also receiving goods now and paying for them later. And trade credit is delivering goods to a customer now and agreeing to receive payment for those goods at a later date. Trade credit terms often require payment within one month of the invoice date, but may also be for longer periods. Most of the commercial transactions between businesses involve trade credit. This type of credit facilitates business to business transactions and is a vital component of any commercial industry.

If a consumer receives goods now and agrees to pay for them later, then the consumer purchased the goods with trade credit. Likewise, if a supplier delivers goods now and agrees to receive payment later, then the sale was made with trade credit. There are two types of trade credit: trade receivables and trade payables. Trade credit payables and receivables can become complex. It is important to manage trade credit properly and accurately.


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Accounting Trade Credit

For accounting trade credit, the value of goods bought on credit is recorded on the balance sheet in an account called accounts payable, representing money the company owes for goods it already received. These are trade payables.

While the value of goods sold on credit is recorded on the balance sheet in an account called accounts receivable, representing the money owed to a company for goods it already delivered to customers. These are trade receivables.

Trade credit is essentially a short-term indirect loan. When a supplier delivers goods to a buyer and agrees to accept payment later, the supplier is essentially financing the purchase for the buyer. Trade credit is an interest-free loan. As long as the buyer postpones payment, the buyer is saving the money that would have been spent on interest to finance the purchase with a loan. At the same time, the supplier is losing the interest it would have earned had it received the payment and invested the cash. Therefore, the buyer wants to postpone payment as long as possible and the supplier wants to collect payment as soon as possible. That is why suppliers often offer discount credit terms to buyers who pay sooner rather than later.

Trade Receivables Definition

Trade receivables represent the money owed but not yet paid to a company for goods or services already delivered or provided to the customer. The goods were delivered. Then the company recorded the sale. But the cash was not yet received. Record trade receivables as an asset on the balance sheet in an account called accounts receivable.

Trade Payables Definition

Trade payables represent the money a company owes but has not yet paid for goods or services that have already been delivered or provided from a supplier. The goods were received, the expense was recorded, but the cash was not yet paid. Trade payables are recorded as a liability on the balance sheet in an account called accounts payable.

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Loan Origination Fee

See Also:
How important is personal credit in negotiating a commercial loan?
Loan Agreement
Loan Term
5 C’s of Credit (5 C’s of Banking)
Mezzanine Debt Financing (Mezzanine Loans)

Loan Origination Fee Definition

The loan origination fee definition is a charge from a lender to a borrower usually for mortgage loans. The origination fee is usually used to cover the cost of issuing the loan itself. The costs range from appraisal and title expenses to a credit check of the person trying to obtain the loan.

Loan Origination Fee Explained

An origination fee loan is normally a discount point (1%), but can range from a half (0.5%) to two point (2%). If it is used solely for cash it can even be deductible if the borrower is purchasing or amortizable if the borrower is refinancing a mortgage loan. A lender’s agreement often discloses an origination fee. You can negotiate it. It should be noted that it is usually higher in a subprime market due to the increased risk.

Loan Origination Fee Example

Tanner is looking to buy a house for $1 million. He goes to Money Bank and obtains a loan with a 1% origination fee. Tanner then uses this cash to buy the house. Tanner immediately owes the origination fee of $100,000 when he purchases the house. Note that Tanner will be able to deduct the fee on his taxes.

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Loan Origination Fee, Loan Origination Fee Definition
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LIBOR (London Interbank Offered Rate)

See Also:
Interest Rate Swaps
Prime Lending Rate
Libor versus Prime Rate
Federal Funds Rate

LIBOR Definition

The LIBOR definition is a benchmark interest rate derived from the rates at which banks are able to borrow funds from one another in the London inter-bank market, is the foundation of all lending rates. Furthermore, this term is a common reference rate for short-term lending transactions around the world. The British Bankers‘ Association publishes this rate daily at approximately 11:30am GMT.

LIBOR Explanation

LIBOR, explained below, is one of the most pivotal lending rates for the entire world. LIBOR rates are based on a filtered average of the market rates at which banks are willing to offer deposits to other banks for certain currencies, maturities, and fixing dates. In addition, LIBOR publishes rates for Australian Dollars, Euros, Japanese Yen, Sterling, US Dollars, and other currencies. Maturities can range from overnight to one year. LIBOR commonly quotes the rates for 1 month, 3 months, 6 months, and 1 year. The fixing date is the date on which the rate is relevant. While actual market rates fluctuate throughout the day, LIBOR remains fixed for 24 hours.

LIBOR as a Reference Rate

LIBOR is used as a reference interest rate for loans to borrowers with good credit as well as loans to borrowers with poor credit.

Example

For example, a borrower with good credit might secure a loan at LIBOR, the reference rate, plus a narrow quoted margin, or the percentage point spread above the reference rate. Meanwhile, a borrower with poor credit might secure a loan at LIBOR plus a wider quoted margin. LIBOR swap rates are also used as a reference rate for currencies, mortgages, interest rate swaps and other financial instruments.

LIBOR Quotes

Overnight LIBOR-Rate

1-month LIBOR-Rate

3-month LIBOR-Rate

6-month LIBOR-Rate

1-year LIBOR-Rate

LIBOR Calculation

LIBOR, calculated daily by the British Bankers’ Association (BBA), is based on a filtered average of inter-bank deposit offer quotes submitted from certain contributor banks.

The BBA selects a panel of at least 8 Contributor Banks for each relevant currency. For example, the Australian Dollar panel consists of 8 banks. The Canadian Dollar panel consists of 12 banks. And the Japanese Yen panel consists of 16 banks. The Contributor Panel selections are based on the banks’ credit standing, reputation, participation in the London inter-bank market, and other relevant factors. The compositions of the Contributor Bank Panels are reviewed annually.

Each day, between 11:00am GMT and 11:10am GMT, each Contributor Bank submits to the BBA the actual rate at which it could borrow funds just before 11:00am GMT on that day in the London inter-bank market for particular currencies, maturities, and fixing dates.

Then the submitted rates are ranked. Then they calculate the mean using only the two middle quartiles of the ranking. For example, if 16 rates are submitted, then calculate the mean using the middle 8 rates. Whereas if 12 rates are submitted, then use the middle 6 rates. And if 8 rates are submitted, then use the middle 4. The calculated mean becomes the London Inter-bank Offered Rate for that particular currency, maturity, and fixing date. The BBA then publishes this rate at approximately 11:30am GMT.

History of LIBOR

LIBOR was established between 1984 and 1985. It provides a standardized rate to facilitate the increasing usage of new financial instruments, such as interest rate swaps, foreign currency options, and forward rate agreements.

LIBOR Historical Rates and Current Rates

For LIBOR rates, see:

bba.org.uk

bankrate.com

bloomberg.com

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LIBOR Definition

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Letter of Credit

See Also:
Line of Credit (Bank Line)
Annual Percentage Rate (APR)
Company Life Cycle
How Important is Personal Credit While Negotiating a Commercial Loan?

Letter of Credit Definition

What are letters of credit? Define a letter of credit as a document issued by a bank that guarantee payment to a seller on behalf of a buyer. Letters of credit essentially eliminate the seller’s risk of non-payment by substituting the bank’s credit for the buyer’s credit.

A letter of credit specifies the payment amount and the time period in which the letter of credit is good. Once a letter of credit has been issued and the terms and conditions of the contract have been met, the bank must make the payment to the seller on behalf of the buyer. Companies often use letters of credit in international transactions, where the buyers and sellers may be unsure of each other’s credit or reliability.

Letter of Credit Explanation

Companies often issues letters of credit in international transactions. They typically involve four parties: the importer, the importer’s bank, the exporter, and the exporter’s bank. Importer’s and exporter’s banks, in this case, simply refer to a commercial bank domiciled in the importer’s country and a commercial bank domiciled in the exporter’s country. The importer may be unsure of the reliability of the exporter and the quality of the exporter’s goods; the exporter may be unsure of the importer’s creditworthiness and ability to make payment. By using banks as intermediaries, you alleviate all of these concerns.

Once an importer and an exporter have agreed to a trade transaction, but before money or goods have changed hands, the importer will go to the importer’s bank and, for a fee, apply for a letter of credit. The importer’s bank then issues a letter of credit for a set amount and a set time period. Then the bank guarantees payment to the exporter as long as the exporter meets the terms and conditions of the contract.

The importer’s bank then sends this letter of credit to the exporter’s bank, saying they’ll guarantee payment once the exporter’s bank provides documents proving the goods have been shipment. Once the importer’s bank sees these documents, the importer’s bank makes a full payment to the exporter’s bank. The exporter can then collect its money from the exporter’s bank and the importer will receive its purchased goods.

Types of Letters of Credit

There are several types of letters of credit, though the most common type is a confirmed irrevocable letter of credit. You cannot change or alter this type of letter of credit in any way without the consent of all relevant parties. Therefore, the issuing bank is obligated pay the seller.

Other types of letters of credit include revocable letters of credit (they may be altered by the issuing bank), revolving letters of credit (automatically renewed periodically to allow for recurring transactions between the same buyer and seller), and traveler’s letters of credit (issued on behalf of traveling customers). They list several banks that will honor the contract.

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Letter of Credit
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Interest Rate Definition

See Also:
Effective Rate of Interest Calculation
Interest Expense
What are the 7 Cs of banking
Time Value of Money (TVM)
Interest Rate Risk
LIBOR vs Prime Rate
Federal Funds Rate Definition
Treasury Inflation Protected Securities

Interest Rate Definition

An interest rate signifies a borrowing cost. The interest rate definition is the rate the lender charges the borrower for the use of money. Quote interest rates as annual rates, which represent a percentage of the borrowed principal. Interest rates are used in all types of business and consumer loans, including auto loans, mortgages, credit cards, and any other contract that involves a borrower and a lender. A borrower with good credit – and therefore less risk of default – can borrow money at a lower rate than a borrower with poor credit.

Benchmark Interest Rates

Business and consumer loans, as well as interest rate derivatives (see below), often rely on benchmark interest rates, such as the fed funds rate, the prime rate, Libor, or U.S. Treasury rates. For example, a company may borrow money from a commercial bank at a rate equal to the prime rate plus a specified quoted margin. The quoted margin, or spread between the benchmark rate and the interest rate used in the loan, would depend on the credit standing of the borrower.

Interest Rate Derivatives

Furthermore, interest rates are also frequently used in financial derivatives, such as interest rate futures and interest rate swaps. With financial derivatives, the value of the derivative instrument depends on fluctuations in the underlying interest rate.

Calculate Interest on Loan

Use the following equations to calculate interest on a loan:

Simple Interest = Principal x Interest Rate x Time Periods

Compound Interest = Principal x (((1 + Interest Rate)^Time Periods) – 1)

Interest Payment = Principal x Interest Rate

Principal = Interest Payment / Interest Rate

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