A.) Explain the characteristics of a line of credit. What is it about these loan

Question

A.) Explain the characteristics of a line of credit. What is it about these loans that make them by far the most popular type of short-term credit?

B.) When the economy is growing at a slow pace, it puts a damper on production and sales. This is due to the fact that many people are trying to build up their lives after the recession and do not spend as much as they would usually spend. When consumers spend less, businesses begin to suffer losses in profit. Working capital management ensures a company has enough cash flow to be able to pay their short-term debts and operating expenses. A slow-growing economy can diminish the importance of working capital management because interest rates are low, so monthly payments are low. It can also costs less to pay for operating costs, so a company does not have to maintain as much working capital. Even though the it is not needed as much, it is still important because without any working capital, the company would not be able to pay any debts or operating costs. The company will still need to have some working capital to keep running.

What are your thoughts, DO you agree or disagree? Elaborate and Explain

Explanation / Answer

A line of credit is an agreement between a lending institution like bank and a company for providing a specific amount of money at an agreed rate for a specified period. The compnay can draw money upto the credit line sanctioned and needs to pay interest on the borrowed amount. The credit line interest rate depends on the credit rating and financial position of the company and is generally higher than term loans. Line of credit is useful to meet temporary fluctuation is working capital as no fixed amount to be borrowed like tern loan and the amount can be paid as soon as working capital is available. Apart from the interest banks charge one time processing fee and maintenance fee for unused credit line.

Line of credit is most popular short term credit as the interest is payable only on the borrowed amount and depending on the need the company can borrow varying amounts unlike other fixed amount loans.

It is true that in a slow going economy the requirement of working capital comes down , but still some amount of working capital will be always needed. As the economy slows down the collection from sales comes down and the collection period also prolongs a bit. Moreover , the fixed opertaing costs do not reduce in proportion to the reduction is sales volume. So quite a large amount of fixed opearting costs still need to be paid . This entails that there will be a gap between current assets and current laibilities and the nedd of working capital still exisits in slow economy.

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