Medium-Term Finance

ACCA P4考試：Medium-Term Finance

1 Bank Loans

Advantages

The loan will be for a fixed term: no risk of early recall (unlike overdrafts that can be called).

The interest rate may be fixed.

Disadvantages

Inflexible.

May require security.

May require covenants, which are restrictions on the company (e.g. limits on dividend payments, limits on further borrowing).

2 Leasing

Advantages

There are many willing providers.

Remains off balance sheet if an operating lease.

Matches finance to the asset.

Very flexible packages available, some of which include maintenance.

Disadvantage

Can be quite costly.

Effect on Financial Statements

When management makes a final decision on whether to borrow to buy an asset, or whether to acquire it under a lease, the respective financial accounting implications may be an important factor.

This is certainly relevant for the managers of a listed company (i.e. whose shares are traded on the stock market) as key ratios may be influenced—particularly financial risk indicators (e.g. debt to- equity ratio and interest cover).

The implications of each financing option can be summarised as follows:

Borrow to buy—The bank loan (or bond) will be recorded in non-current liabilities and will hence increase the firm's reported level of financial gearing (debt-to-equity ratio). Interest on the debt will reduce the firm's interest cover (earnings before interest and tax⁄interest expense). However, the overall effect also depends on the profits generated by the asset as these will increase the EBIT figure, and any retained profit would increase the level of equity.

Operating lease—Neither the asset nor any related liability would be shown in the statement of financial position. Operating leases are a form of "off balance sheet" finance (although commitments under operating leases would be disclosed in the notes to the accounts). Therefore, reported financial gearing would not rise. Although rental expense would be charged against EBIT this should be outweighed by the returns generated by operating the asset.

Finance lease—Both the asset, and a related liability, would be recognised on the statement of financial position (as per the borrow-to-buy option). Hence reported financial gearing would initially rise. However lease payments would be split between interest expense and repayment of principal (similar to a mortgage-style loan) and hence the liability would amortise over time and ultimately fall to zero. Interest expense in early years would be relatively high, tending to reduce interest cover, but lower in later years.

3 Sale and Leaseback

Property is sold to an institution (e.g. a pension fund) and then leased back to the company.

Advantages

Funds are raised from the sale.

May improve ratios such as Return On Capital

Employed (ROCE).

Disadvantages

No longer own the property and hence cannot participate in any future increase in value.

Risk of lease payments increasing.