Long-term versus short-term financing
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There are several issues to take into account when deciding between long-term
and short-term borrowing, including the following:
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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.
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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.
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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.
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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.
