Advance Accounting

Short Term and Long Term Business Loans

Date: 14.11.2016

Submitted To:

Ms. Rabia Aslam

Submitted By:

Nimra Hafeez

Roll no: 9155140

Class: B.com III

Session: 2015-2019
 Contents

Topic No Topic Name Page No

01. Introduction 01

02. Business Loans

I. Short term loan

II. Long term loan 02

03. Short-Term Loan

i. Overdraft
ii. Credit Card
iii. Pay Day Loan
iv. Money Market
v. Refund Anticipated Loan (RAL)
vi. Bridge Loan 03-04

04. Long-Term Loan

i. Shares
ii. Debentures
iii. Bonds
iv. TFC’s 05-06

05. Types of Debentures 07-09

06. Types of Bonds 09-10

07. Difference between Shares and Debentures 10-11

 01. Introduction

Why a company would take loan? Small businesses take out commercial bank loans for a variety
of reasons. Loans can come from other sources as well. Credit unions make loans to small
businesses. Loans can be made using accounts receivable or inventory as collateral. Borrowing
money is expensive for a company and raises its risk. In addition to the risk of whatever
enterprise you are undertaking, borrowing money introduces another level of risk to your
company. Regardless, debt is one of the forms of financing small business operations. Here are
four reasons that companies often use debt financing. Banks are likely to loan money to existing
firms that want to purchase real estate to expand their operations. If a firm is expanding, then the
bank knows the firm is successful and it wants the firm to keep on doing what it's doing.
Expansion generally only happens if the firm is turning a profit and a positive cash flow and has
positive forecasting numbers for the future. Businesses have a couple of choices with regard to
the acquisition of equipment. They can buy it or they can lease it. Banks sometimes make loans
to small businesses to purchase inventory. Some small businesses are seasonal in nature,
particularly retail businesses. If a business makes most of its sales during the holiday season,
they want to purchase most of their inventory prior to the holiday season. They may need a bank
loan prior to the holiday season to purchase a large amount of inventory to gear up for that time.
Bank loans to purchase inventory are generally short-term in nature and companies usually pay
them off after the season is over with the proceeds of sales from their seasonal sales. Working
capital is the money you use to manage your day-to-day operations. Small businesses sometimes
need loans to meet their daily operations needs until their earning assets are sufficient to cover
their working capital needs. Banks sometimes loan short-term money to small businesses to
enable them to get off the ground and grow. As the business grows and their own assets enable
them to earn money, they can repay the working capital loan to the bank. Working capital loans
may have higher interest rates than, for example, real estate loans, since banks consider them
riskier. All but the smallest of businesses may use both debt and equity financing in financing
their business. Bank loans through commercial banks are the most common way of obtaining
debt financing.

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 02. Business Loans

A business loan is a loan specifically intended for business purposes. As with all loans, it
involves the creation of a debt, which will be repaid with added interest. There are a number of
different types of business loan, suited to the requirements of different types of business such as
bank loans, mezzanine financing, asset-based financing and invoice financing. There are two
major types of business loans based on period.

Loans

Short- Long-
Term Term
Loan Loan

I. Short-Term Loans
A loan scheduled to be repaid in less than a year. When your business doesn't qualify for a
line of credit from a bank, you might still have success in obtaining money from then in the
form of a one-time, short-term loan (less than a year) to finance your temporary working
capital needs.

II. Long-Term Loans

A loan for equipment, real estate and working capital that's paid off like a mortgage for
between one year and ten years. Term loan are your basic vanilla commercial loan. They
typically carry fixed interest rates and monthly or quarterly repayment schedules and include
a set maturity date. Long-term debt consists of loan and financial obligations lasting over one
year. Long-term debt for a company would include any financing or leasing obligations that
are to come due in a greater than 12-month period.

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 03. Short-Term Loan

Short term loans are borrowed funds used to meet obligations within a few days up to a year.
The borrower receives cash from the lender more quickly than with medium and long term loans
and must repay it in a short time frame. Short-term loans are often easier to obtain than their
traditional counterparts While larger banks provide most of the traditional loans in this country,
entrepreneurs can secure short-term loans through smaller banks and lender like credit unions.
There are some kinds of short term loans as following.

Short-
Term
Loan

Credit Pay Day Money Refund Bridge

Overdraft Anticipati
Card Loans Market Loan
on Loan
(RAL)

i. Overdraft
An overdraft is an extension of credit from a lending institution when an account reaches
zero. An overdraft allows the individual to continue withdrawing money even if the account
has no funds in it or not enough to cover the withdrawal. Basically, overdraft means that the
bank allows customers to borrow a set amount of money.

ii. Credit Card

A credit card is a card issued by a financial company giving the holder an option to borrow
funds, usually at point of sale. Credit cards charge interest and are primarily used for short-
term financing. Interest usually begins one month after a purchase is made, and borrowing
limits are pre-set according to the individual's credit rating.
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iii. Pay Day Loan
A payday loan is a type of short-term borrowing where an individual borrows a small amount
at a very high rate of interest. The borrower typically writes a post-dated personal check in
the amount they wish to borrow plus a fee in exchange for cash. The lender holds onto the
check and cashes it on the agreed upon date, usually the borrower's next payday.
These loans are also called cash advance loans or check advance loans.

iv. Money Market

The money market is where financial instruments with high liquidity and very short
maturities are traded. It is used by participants as a mean for borrowing and lending in the
short term, with maturities that usually range from overnight to just under a year.

v. Refund Anticipation Loan (RAL)

A loan provided by a third party against a taxpayer's expected refund. The
tax refund anticipation loan is not provided by the U.S. Treasury or the IRS and is subject to
the interest and fees set by the lender. These loans are most often offered by large tax
preparation companies to taxpayers expecting refunds of a few thousand dollars or less.

vi. Bridge Loan

A bridge loan is a short-term loan used until a person or company secures
permanent financing or removes an existing obligation. This type of financing allows the user
to meet current obligations by providing immediate cash flow. The loans are short term, up to
one year, with relatively high interest rates and are usually backed by some form
of collateral such as real estate or inventory.

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 05. Long-Term Loan

Long-term financing is a form of financing that is provided for a period of more than a year. Long
term financing services are provided to those business entities that face a shortage of capital. There
are various long term sources of finance. It is different from short term financing which is normally
used to provide money that has to be paid back within a year. The period may be shorter than one
year as well. The term “Term Loan” is used for long term loan.

Purpose of Long Term Finance:

1. To finance fixed assets.

2. To finance the permanent part of working capital.
3. Expansion of companies.
4. Increasing facilities.
5. Construction projects on a big scale.
6. Provide capital for funding the operations.

Types of
Term Loan

Financial Commerci
Shares Debenture Bonds TFCs
Institution al Banks

i. Shares

Share is unit into which the total capital of a company is divided. As per Section 85 of the
Companies Act, 1956, a public limited company can issue the following two kinds of shares
Preference shares and Equity shares.

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I. Preference Shares
These are the shares which carry a preferential right over equity shares with reference to
dividend. They also carry a preferential right over equity shares with reference to the payment of
capital at the time of winding up or repayment of capital. The preference shares may be of
various types such as cumulative and non-cumulative, redeemable and irredeemable,
participating and non-participating and convertible and non-convertible.

II. Equity Shares

Shares which are not preference share are equity shares. In other words, equity shares are entitled
to dividend and capital after the payment of dividend and capital on preference shares. There are
two types of capitals:

 Preference Share Capital

 Equity Share Capital

ii. Debentures

Issue of debentures is another method of raising term loans from the public. A debenture is
an instrument acknowledging a debt by a company to a person or persons. “Debenture
includes debenture stock, bonds and any other securities of the company whether constituting
a charge on the company’s assets or not.” A company can issue various types of debentures,
viz. redeemable and irredeemable, registered and bearer, secured and unsecured and
convertible and non-convertible debentures. The procedure for the issue of debentures is,
more or less, the same as those for the issue of shares. A long-term security yielding a fixed
rate of interest issued by a company and secured against assets.

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 06. Types of Debentures

The major types of debentures are as follows:

1. Types of Debentures on The Basis of Record Point of View

a. Registered Debentures

These are the debentures that are registered with the company. The amount of such debentures is
payable only to those debenture holders whose name appears in the register of the company.

b. Bearer Debentures

These are the debentures which are not recorded in a register of the company. Such debentures
are transferable merely by delivery. Holder of bearer debentures is entitled to get the interest.

2. Types of Debentures on The Basis of Security

a. Secured or Mortgage Debentures

These are the debentures that are secured by a charge on the assets of the company. These are
also called mortgage debentures. The holders of secured debentures have the right to recover
their principal amount with the unpaid amount of interest on such debentures out of the assets
mortgaged by the company.

b. Unsecured Debentures

Debentures which do not carry any security with regard to the principal amount or unpaid
interest are unsecured debentures. These are also called simple debentures.

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3. Types of Debentures on The Basis of Redemption

a. Redeemable Debentures

These are the debentures which are issued for a fixed period. The principal amount of such
debentures is paid off to the holders on the expiry of such period. These debentures can be
redeemed by annual drawings or by purchasing from the open market.

b. Non-redeemable Debentures

These are the debentures which are not redeemed in the life time of the company. Such
debentures are paid back only when the company goes to liquidation.

4. Types of Debentures on The Basis of Convertibility

a. Convertible Debentures

These are the debentures that can be converted into shares of the company on the expiry of pre-
decided period. The terms and conditions of conversion are generally announced at the time of
issue of debentures.

b. Non-convertible Debentures

The holders of such debentures cannot convert their debentures into the shares of the company.

5. Types of Debentures on The Basis of Priority

a. First Debentures

These debentures are redeemed before other debentures.

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b. Second Debentures

These debentures are redeemed after the redemption of first debentures.

iii. Bonds

A bond is a debt investment in which an investor loans money to an entity which borrows the
funds for a defined period of time at a variable or fixed interest rate. Bonds are used by
companies, municipalities, states and sovereign governments to raise money and finance a
variety of projects and activities. Owners of bonds are debt holders, or creditors, of the issuer.

07. Types of Bonds

Government Bonds

In general, fixed-income securities are classified according to the length of time before maturity.
Marketable securities from the U.S. government - known collectively as Treasuries - follow this
guideline and are issued as Treasury bonds, Treasury notes and Treasury bills (T-bills).
Technically speaking, T-bills aren't bonds because of their short maturity. All debt issued by
Uncle Sam is regarded as extremely safe, as is the debt of any stable country. The debt of many
developing countries, however, does carry substantial risk. Like companies, countries can default
on payments.

Municipal Bonds

Municipal bonds, known as "municipals", are the next progression in terms of risk. Cities don't
go bankrupt that often, but it can happen. The major advantage to municipals is that the returns
are free from federal tax. Furthermore, local governments will sometimes make their debt non-
taxable for residents, thus making some municipal bonds completely tax free. Because of these
tax savings, the yield on a municipal is usually lower than that of a taxable bond. Depending on
your personal situation, a municipal can be a great investment on an after-tax basis.

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Corporate Bonds

A company can issue bonds just as it can issue stock. Large corporations have a lot of flexibility
as to how much debt they can issue: the limit is whatever the market will bear. Generally, a
short-term corporate bond is less than five years; intermediate is five to 12 years, and long term
is over 12 years. Corporate bonds are characterized by higher yields because there is a higher
risk of a company defaulting than a government. The upside is that they can also be the most
rewarding fixed-income investments because of the risk the investor must take on. The
company's credit quality is very important: the higher the quality, the lower the interest rate the
investor receives.

4. Term Finance Certificates (TFC)

A Term Finance Certificates (TFC) is a corporate debt instrument issued by companies in
Pakistan to generate short and medium-term funds. Corporate Term Finance Certificates (TFC’s)
offer institutional investors, in particular provident funds, pension funds and insurance
companies, with a viable high yield alternative to the NSS and bank deposits. They are also an
essential complement to risk free, lower yielding government bonds such as PIB’s. As a
result, the demand for TFC’s is growing steadily, and will gather increasing momentum in the
future
.

08. Difference between Shares and Debentures

The major points of distinction between shares and debentures are as follows:
1. Representation:
A share represents a portion of capital whereas a debenture represents a portion of debt of a
company.

2. Status:
A shareholder is a member of the company, but a debenture holder is a creditor of the company.

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3. Return:
A shareholder is paid dividend while a debenture-holder is paid interest.

4. Right of Control:
The shareholders have a right of control over the working of the company whereas the
debenture-holders don’t have such right.

5. Repayment:
Debentures are normally issued for a specified period after which they are repaid. But, such
repayment is not possible is case of shares.

6. Purchase:
A company cannot purchase its own shares from the market, but it can purchase its own
debentures and cancel them.

7. Order of Repayment:
In liquidation, debenture-holders get priority in payment, but shareholders are the last to get
payment after all claims have been fully satisfied.

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