Any firm that is planning on starting up a new business or expanding into new business ventures requires adequate capital to do so. This is the point at which the company’s top managers are faced with a decision on their hands, as to whether they should go forward and obtain short term or long term financing. Long term and short term financing are different to each other mainly because of the time period for which the finance is provided, or the debt/loan repayment period. The following article provides an explanation of what short term and long term financing are with examples and outlines the differences between the two forms of financing.
Short-term Financing
Short term financing usually refers to financing that spans a period of less than a year to one year. However, such financing can also go up to around 3 years depending on the types of loan/debt being considered. For example, a 3 year mortgage would be considered to be short term in comparison to a long term mortgage that lasts around 15-30 years.
Since short term financing involves a shorter repayment period, the interest rate to be paid on short term financing is lower. Furthermore, since the risk with such short term financing is lower, any company, especially smaller firms, will have easy access to short term financing. Types of short term financing can include accounts payable, bank overdrafts, short term loans, short term leases, etc.
Long-term Financing
Long term financing refers to financing that spans a longer period of time that could go up to about 3-30 years or more. Long term loans are riskier in nature, and banks or financial institutions providing the loan have more to lose since the amount borrowed is larger, and period of repayment is longer. Therefore, when banks offer longer term loans some form of collateral is required to ensure that the borrower will not default on his repayment.
Since long term financing is riskier and is for a longer time period, the interest charged on longer term financing will be higher. Types of long term financing include, issuing shares, bonds, long term bank loans, long term leases, retained earnings, etc.
Long-term vs Short-term Financing
Long term and short term financing both offer firms some sort of temporary or long term support in times of financial distress. Short term financing is relatively easier to obtain and is frequently used by smaller and larger firms alike. Long term financing, on the other hand, is more difficult and riskier to obtain, therefore, only larger firms or firms with strong collateral can obtain long term loans. The other major difference between the two forms of financing is that shorter term financing as it names suggests is for shorter periods and is usually used to obtain temporary financial relief from short term shortage of funds. Longer term financing is used for larger investments or projects for which larger sums of funds are required for an extended period of time.
Summary:
• Long term and short term financing are different to each other mainly because of the time period for which the finance is provided, or the debt/loan repayment period.
• Short term financing usually refers to financing that spans a period of less than a year to one year. Since the risk with such short term finances is lower, any company especially smaller firms will have easy access to short term financing.
• Long term financing refers to financing that spans a longer period of time that could go up to about 3-30 years or more. Long term loans are riskier and banks or financial institutions providing the loan have more to lose since the amount borrowed is larger and period of repayment is longer.