The most common way that firms obtain cash for temporary financing is through a short-term bank loan. These short-term bank loans are called notes payable and are accompanied by promissory notes.
A line of credit allows a firm to borrow cash without having to follow formal loan procedures and paperwork. It provides a company with short-term financing with amounts drawn by the borrower only when needed. Lines of credit can be noncommitted or committed.
Committed lines of credit. This is a line of credit that has a formal agreement and requires the company to pay a commitment fee to keep the line of credit open.
Noncommitted lines of credit. Informal agreement. Company can borrow up to a pre-specified amount, no questions asked.
Interest can be thought of as "rent" charged by a lender to a lendee for allowing the lendee to use money for a period of time. Interest is typically stated in annual percentage rates (e.g., lender charges lendee 5% of loaned amount per year).
If a loan is taken in the middle of the year, the interest expense calculation needs to be adjusted for the portion of the year the loan was outstanding.
where "n" is the number of months the loan was outstanding.
A non-interest bearing note is a loan in which interest is deducted from the face amount of the loan to determine the cash proceeds made available to the borrower at the outset.
Effective interest rate = Interest expense / face amount of loan = $42,000 / $658,000 = 6.4%
This is a 6 month charge. So the effective, annualized interest rate is 6.4% * (12 months / 6 months) or 12.8%.