FIN 200 Week 5 CheckPoint Long-Term and Short-Term Financing
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FIN 200 Week 5 CheckPoint Long-Term and Short-Term Financing
Both new and established businesses will find it necessary to incur debts during the course of business operations. Financing may be sought for a multitude of reasons – like smoothing cash flow, purchasing equipment, or expanding operations. The choice between short- and long-term financing options should be determined based on each business’ individual needs. To make that determination, businesses also need to understand when each type of financing is appropriate.
For financing needs over a period of a year or less, sort term financing can be used to inject capital into businesses. Short term financing options include short-term loans, letters of credit, promissory notes, over drafting, and inventory loans. These options are often used by businesses to cover day-to-day costs like supplies, inventory orders, and wages. Due to the nature of their shifting demands, seasonal businesses in particular often use short term finance arrangements. An example of short-term financing is a company signing a short-term loan in order to purchase more inventory. Proceeds from sales of goods would be used to repay the loan. This is appropriate only if the capital required by the firm can be paid off within the loan’s timeframe.
For financing needs over a longer length of time (greater than a year), long-term financing can be used. Long-term financing is used when businesses want to invest in equipment that improve business operations over a longer period of time. Options for long-term financing include fixed deposit loans, convertible notes, secured and unsecured notes, and mortgages. One example of long-term financing is if a business wanted to expand its production facilities. Production and profits would be increased in the long-term, which in turn would allow the business to repay its financing.
In sum, both short- and long-term financing can be useful options for businesses to succeed.
Source:
Ross Thompson Christensen Westerfield Jordan, 'Fundamentals of Corporate Finance', 2nd edition, 2001 , 466-499, 502-534.