The time between when the lender extends credit and when the business must repay principal and interest is the main difference between the categories of financing. Finding financial balance between long-term vs. short-term debt is essential to businesses’ ability to thrive.
Short-Term Financing Sources
There are a large number of short-term financing vehicles for businesses. Banks provide different types of short-term credit facilities and loans. Cash flow shortfalls may create overdrafts and protection against this may also reflect the time between
Businesses can take advantage of a wide range of short-term financing sources. Banks offer short-term loans and credit lines to address time gaps between accounts payable and accounts receivable.
Vendors also provide businesses with goods on credit. A business is provided with goods and is offered a time window before vendors’ invoices become due. This arrangement, known as trade credit, may provide the business with enough time to sell goods before the bill must be paid.
Businesses may also use credit cards as a short-term financing tool. An owner may use his or her own credit cards to pay for company purchases or apply for credit in the business name. Factoring companies are another resource to businesses. These firms sell businesses’ invoices for a percentage of current value in exchange for cash in hand.
Long-Term Financing Sources
There are fewer long-term financing vehicles for businesses. The lender, such as a bank, requires that the business maintain a certain cash reserve to carry a long-term loan. Banking institutions offer these loans but the lending approval process is exhaustive. The bank must scrutinize borrowers’ ability to repay.
Other sources of financing, including venture capital firms or angel investors, lend money to innovative businesses. These investors realize that the new firm may need several years of financial assistance before it makes a profit.
The Small Business Administration (SBA) can also help businesses find loans, but borrowers do not receive loan funds directly from SBA.
Economic development groups and organizations occasionally provide stipends and loans to young businesses, especially when a banker provides loan funds.
Short-term financing options are typically one year or less in term. Trade credit is very near term, about 30 to 90 days. A bridge loan term is a short-term financing vehicle. Although banks do offer one to three year loan terms, these facilities are less common today than in past decades.
Long-term interest rates are at historically low levels, and most lenders believe that interest rates will climb to higher levels in the next one to three years. For this reason, many banks and lenders are less enthusiastic about arranging long-term loans for businesses other than their very best customers.
Long-term bank loans with 10 to 20 year terms may be easier for many businesses to manage. Venture capitalists may also take a longer-term view, but most have a clear time line and a liquidity event or other exit strategy in mind before making an investment. Generally speaking, these investors are not in the business of extending long-term financing facilities.
Short-term financing is usually less expensive than long-term vehicles, although some tools like credit cards may subject the cardholder to high annual percentage rates if the balance is not paid in full each billing cycle.
Working with a venture capital firm or angel investors frequently entails giving away a percentage of business ownership. Since these investors are part-owners, they are likely to demand the right to participate in decisions made by the business.
Finding Financial Balance
Business must have capital to grow. Some businesses direct capital towards sales growth. Others merge or partner with a better capitalized business to fuel expansion.