SHORT TERM FINANCING STRUCTURE

Conceptual considerations

Companies need funds to finance different types of assets. Assets may be long-term as well as short-term ones. Short-term assets are the current assets. They are also knows as working capital. Working capital financing needs short-term funds. Short-term funds include a company’s entire debt obligations that originally were scheduled for repayment within one year. Therefore, short-term financial decisions generally involve short-lived assets and liabilities. A financial manager responsible for short-term financial decisions does not have to look far into the future. But a long-term financing decision required looking far into the future. For example, a bond issue decision will normally reflect forecast cash requirements 5, 10 or more years into the future. Short-term decisions are easier than long-term decisions but they are no less important than the latter.

A variety of short-term credits are available to a firm. A financial manager should always take into account the advantages and disadvantages of each source are explained in the explanation of each component but here the advantages and disadvantages of overall shot-term funds have been described.

Advantages

Speed: - A short term loan can be obtained much faster than a long-term one. For example, raising fund through bond issues requires registration of bond, selection of issue manager, issue of bonds, allotment of bond etc. But a short-term loan does not require such a long process.

Flexibility: - If the funds are needed for seasonal or cyclical purposes, a firm may not want to commit itself to long-term debt for three reasons:

ü       Flotation costs are higher for long-term debt than for short-term credit.

ü       Long-term loan agreements always contain provisions, or covenants, which constrain the firm’s future actions. Short-term credit agreements are generally less restrictive.

ü       Although long-term debt can be repaid early, provided the loan agreement includes a prepayment provision, prepayment penalties can be expensive. Accordingly, if a firm thinks its need for fund will diminish in the near future, it should choose short-term debt.

Cost: - Interest rates are generally lower on short-term debt. Thus, under normal conditions, interest costs at the time the funds are obtained will be lower if the firm borrows on a short-term rather than a long-term basis.

Restriction: - The short-term financing may have less restrictive convenience than long term financing agreement for example restriction on additional borrowing in bond contract.

Collateral: - Long-term borrowing requires collateral but most of the short-term borrowing may not require such collateral.

Disadvantages

Financing: - Long-term sources can be used to finance both long-term as well as short-term assets but short-term financing is used only to finance current assets.

Risk: - The cost of shot-term financing is less than that of long-term sources but it is to be noted that short-term financing is riskier as compared to long-term financing. The repayment time is short and a short time is riskier than a long time. A firm having weak financial performance must decrease its credit-worthiness and inability to make repayment sometimes can lead to bankruptcy.

Fluctuation in interest: - If a firm borrows on a long-term basis, its interest cost will be relatively stable overtime, but if it uses short-term credit, its interest rates will fluctuate widely, at times, going quite higher.