Long Term And Short Term Financing Pdf

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The benefits of long-term and short-term financing can be best determined by how they align with different needs. After a company grows beyond short-term, asset-based loans, they will typically progress to short-term, cash-flow based bank loans. At the point when a company starts to gain scale and establish a track record, they may access either cash-flow or asset-based, long-term financing, which has several strategic benefits.

Debt financing is money that you borrow to run your business, as opposed to equity financing , in which you raise money from investors who are in return entitled to a share of the profits from your business. You can think of debt financing as being divided into two categories based on the type of loan you're seeking, long-term and short-term. Long-term debt financing generally applies to assets your business is purchasing, such as equipment, buildings, land, or machinery. A lender will normally require that long-term loans be secured by the assets to be purchased. With long-term debt financing, the scheduled repayment of the loan and the estimated useful life of the assets often extends for three-to seven-year terms.

Sources of Long term Financing

The main sources of short-term financing are 1 trade credit, 2 commercial bank loans, 3 commercial paper, a specific type of promissory note , and 4 secured loans. A firm customarily buys its supplies and materials on credit from other firms, recording the debt as an account payable.

This trade credit, as it is commonly called, is the largest single category of short-term credit. Credit terms are usually expressed with a discount for prompt payment.

Thus, the seller may state that if payment is made within 10 days of the invoice date, a 2 percent cash discount will be allowed. If the cash discount is not taken, payment is due 30 days after the date of invoice. The cost of not taking cash discounts is the price of the credit.

Commercial bank lending appears on the balance sheet as notes payable and is second in importance to trade credit as a source of short-term financing.

Banks occupy a pivotal position in the short-term and intermediate-term money markets. A single loan obtained from a bank by a business firm is not different in principle from a loan obtained by an individual. The firm signs a conventional promissory note. Repayment is made in a lump sum at maturity or in installments throughout the life of the loan.

A line of credit, as distinguished from a single loan, is a formal or informal understanding between the bank and the borrower as to the maximum loan balance the bank will allow at any one time. Commercial paper is issued for periods varying from two to six months. The rates on prime commercial paper vary, but they are generally slightly below the rates paid on prime business loans. A basic limitation of the commercial-paper market is that its resources are limited to the excess liquidity that corporations, the main suppliers of funds, may have at any particular time.

Another disadvantage is the impersonality of the dealings; a bank is much more likely to help a good customer weather a storm than is a commercial-paper dealer. The most common types of collateral used for short-term credit are accounts receivable and inventories. Financing through accounts receivable can be done either by pledging the receivables or by selling them outright, a process called factoring in the United States. When a receivable is pledged, the borrower retains the risk that the person or firm that owes the receivable will not pay; this risk is typically passed on to the lender when factoring is involved.

When loans are secured by inventory, the lender takes title to them. He may or may not take physical possession of them. Under a field warehousing arrangement, the inventory is under the physical control of a warehouse company, which releases the inventory only on order from the lending institution. Canned goods, lumber, steel, coal, and other standardized products are the types of goods usually covered in field warehouse arrangements.

Whereas short-term loans are repaid in a period of weeks or months, intermediate-term loans are scheduled for repayment in 1 to 15 years. Obligations due in 15 or more years are thought of as long-term debt. The major forms of intermediate-term financing include 1 term loans, 2 conditional sales contracts, and 3 lease financing. A term loan is a business credit with a maturity of more than 1 year but less than 15 years.

Usually the term loan is retired by systematic repayments amortization payments over its life. It may be secured by a chattel mortgage on equipment, but larger, stronger companies are able to borrow on an unsecured basis. Commercial banks and life insurance companies are the principal suppliers of term loans.

The interest cost of term loans varies with the size of the loan and the strength of the borrower. Term loans involve more risk to the lender than do short-term loans. To protect themselves, lenders often include in the loan agreement stipulations that the borrowing company maintain its current liquidity ratio at a specified level, limit its acquisitions of fixed assets, keep its debt ratio below a stated amount, and in general follow policies that are acceptable to the lending institution.

Conditional sales contracts represent a common method of obtaining equipment by agreeing to pay for it in installments over a period of up to five years. The seller of the equipment continues to hold title to the equipment until payment has been completed. It is not necessary to purchase assets in order to use them. Railroad and airline companies in the United States, for instance, have acquired much of their equipment by leasing it.

Leasing provides an alternative method of financing. It is generally advantageous for a firm to own its land and buildings, because their value is likely to increase, but the same possibility of appreciation does not apply to equipment. The statement is frequently made that leasing involves higher interest rates than other forms of financing, but this need not always be true. Moreover, it is difficult to separate the cash costs of leasing from the other services that may be embodied in a leasing contract.

If the leasing company can perform nonfinancial services such as maintenance of the equipment at a lower cost than the lessee or someone else could perform them, the effective cost of leasing may be lower than other financing methods. Although leasing involves fixed charges, it enables a firm to present lower debt-to-asset ratios in its financial statements.

Many lenders, in examining financial statements, give less weight to a lease obligation than to a loan obligation. Business finance Article Media Additional Info. Article Contents. Load Previous Page. Short-term financing The main sources of short-term financing are 1 trade credit, 2 commercial bank loans, 3 commercial paper, a specific type of promissory note , and 4 secured loans.

Trade credit A firm customarily buys its supplies and materials on credit from other firms, recording the debt as an account payable. Commercial bank loans Commercial bank lending appears on the balance sheet as notes payable and is second in importance to trade credit as a source of short-term financing. Intermediate-term financing Whereas short-term loans are repaid in a period of weeks or months, intermediate-term loans are scheduled for repayment in 1 to 15 years.

Term loans A term loan is a business credit with a maturity of more than 1 year but less than 15 years. Conditional sales contracts Conditional sales contracts represent a common method of obtaining equipment by agreeing to pay for it in installments over a period of up to five years.

Lease financing It is not necessary to purchase assets in order to use them. Load Next Page.

Short-Term Financing of Working Capital

The main sources of short-term financing are 1 trade credit, 2 commercial bank loans, 3 commercial paper, a specific type of promissory note , and 4 secured loans. A firm customarily buys its supplies and materials on credit from other firms, recording the debt as an account payable. This trade credit, as it is commonly called, is the largest single category of short-term credit. Credit terms are usually expressed with a discount for prompt payment. Thus, the seller may state that if payment is made within 10 days of the invoice date, a 2 percent cash discount will be allowed.

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Sources of Long term Financing

Long-term debt does offer some financing advantages for businesses. If you don't want to give up some of your ownership to investors, you can use loans to finance growth. However, carrying a high level of long-term debt can present risks and financial challenges to your ability to thrive over time. A major drawback of long-term debt is that it restricts your monthly cash flow in the near term. The higher your debt balances, the more you commit to paying on them each month.

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Chapter Eight Strategies for Short-and Long-Term Financing Options

Financing is a very important part of every business. Firms often need financing to pay for their assets, equipment, and other important items. Financing can be either long-term or short-term.

Short-Term Financing

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Chapter Eight Strategies for Short-and Long-Term Financing Options

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