Sub: Finance Topic: Debt Financing
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Short-Term Debt Capital
Short-term debt must be repaid with interest within a year, and often in 30, 60, or 90 days. Short-termdebt capital is usually obtained from a bank or other lending institution but may be obtained fromother businesses as well.
OBTAINING FUNDS FROM BANKS
Before lending, banks want to be fairly certain that theborrowers will repay their loans. The business will need to supply adequate financialinformation, and the bank will usually obtain a financial report on the business from acompany. To allow the business flexibility to choose when to use the borrowed money, thebank may approve a line of credit. A
line of credit
is the authorization to borrow up to amaximum amount for a specified period of time. Another form of debt equity similar to anopen line of credit is a business credit card, often used by small businesses. The credit card isissued by the bank with a set credit limit. The card can be used to finance purchases as long asthe limit is not exceeded. Both the open line of credit and the credit card carry an interest ratethat is usually lower than similar interest rates charged to consumers for short-term loans andpersonal credit cards. Normally, businesses have to pay the interest due on the loan monthlyand may have a specific payment schedule for the principal as well. When a business wants toborrow money from a lending institution, whether the business has a line of credit or not, itmust sign a promissory note. A
is an unconditional written promise to pay tothe lender a certain sum of money at a particular time or on demand. If the bank has somedoubt about the ability of the firm to repay a loan, it may require the business to pledge itsaccounts receivable, inventory, or some other asset of significant value as security for the loan.If the loan is not repaid, the bank can claim the property pledged as security and sell it toobtain the value of the unpaid loan.