Short-Term and Long-Term Financing, Financing Method:
Sources of finance are important for business operation. Two main types of financing business are short-term and long-term financing.
Short-term financing is less expensive (low interest rate) for business but it is riskier than long-term financing.
The advantages and disadvantages of short-term financing are as follows:
- Interest rates of short-term financing are lower than long-term financing.
- Short-term rates are more volatile than long-term financing because short-term loans are due date and interest rates of renewing loans will change.
- Risk of default of loan may happen if sales of company slow down.
- Bank may not extend or renew loans, so it is risk for shortage of fund for business operation.
Long-term financing is more expensive (high interest rate) than short-term financing but it is less risky.
The advantages and disadvantages of long-term financing are as follows:
- For long-term financing, company has capital at all times.
- Interest rates of long-term financing are higher than short-term financing.
- Company may pay interest on excess funds you don’t always need during borrowing period.
In practice, company will decide to use the appropriate “mix” financing between short and long term loan.
Methods for Financing Loan
As mentioned above, mix short and long term financing is good way for operation. Company will match liquidity (life) of assets to the maturity (life) of company loan, so means assets will be generating cash when liabilities come due.
Balanced short and long term financing are as follows:
- Temporary (seasonal) inventory and accounts receivable will be financed with trade credit, short-term bank loans and short-term notes payable.
- Permanent (minimum) inventory, receivables, property and equipment and long-term investments will be financed with long-term loans, leases, bonds, capital stock, retained earnings.