Self liquidating loan definition
Interest on a loan may be paid either at maturity (ordinary interest) or in advance (discounting the loan). The proceeds of this loan are smaller than the previous one: Proceeds = principal – interest = ,000 – ,800 = ,200 : ABC Bank will give a company a 1-year loan at an interest rate of 20 percent payable at maturity, while DEF Bank will lend on a discount basis at a 19 percent interest rate. ABC Bank = 20% DEF Bank = 19% / 81% = 23.5% When a loan has a compensating balance requirement associated with it, the proceeds received by the borrower are decreased by the amount of the balance.When interest is paid in advance, the proceeds from the loan are reduced and the effective (true) interest cost is increased. The compensating balance will increase the effective interest rate. First, you need to count the required compensating balance, here it is: 0.13 x 5,000 = ,750 ,250 Second, calculate effective interest rate (with line of credit): [interest rate (on loan) x principal)] / principal – compensating balance = (0.18 x 5,000) / (5,000 – ,250) = ,500 / 6,750 = 21.8% On an installment loan, the effective interest rate computation is more involved.
The disadvantages relate to the collateral requirements and the additional financial information that must be presented to the bank.Through extensive case examples, this post provides guideline what steps, calculations and analysis are needed to be performed to decide if a company should use a bank loans financing or receivable factoring.