5.6 Long-term versus short-term financing

Long-term versus short-term financing - There are several issues to take into account when deciding between long-term and short-term borrowing, including the following: Matching: Borrowing to match the nature of an asset on the basis of time or permanency. Non-current (long-term) and permanent current assets are financed by long-term borrowing and current (short-term) assets are financed by short-term borrowing. Flexibility: Short-term borrowing may be useful to postpone making a commitment to a long-term loan, especially if interest rates are high but are forecast to fall in the future. Short-term borrowing does not usually incur penalties if the business makes an early repayment of the amount outstanding, whereas some form of financial penalty may be incurred if long-term borrowing is repaid early. Re-funding risk: Short-term borrowing has to be renewed more frequently than long-term borrowing. This may create problems for a business in financial difficulties or if there is a shortage of funds available for lending. Interest rates: Interest payable on long-term debt is often higher than for short-term debt because lenders require a higher return when their funds are locked up for a long period. This may make short-term borrowing a more attractive source of finance for a business. Other set-up costs (such as renewable fees) should also be considered.
LONG-TERM VS SHORT-TERM, BORROWING - The broad consensus on financing seems to be that all the permanent financial needs of the business should come from long-term sources. Only that part of current assets that fluctuates on a short-term, probably seasonal, basis should be financed from short-term sources. - Listen to Dr Walid Bakry compare long- and short-term finance options available to an organisation. VIDEO
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