equipment, motor vehicle, technical expertise,
Business Finance
Prof. Warren B. Batac, MBA, LPT
TOPIC 1 - INTRODUCTION TO BUSINESS
FINANCE
I. Definition of Finance
A business is an entity, in which the skills,
energy, and enterprise of owners and partners are
linked with money, its sources, and investment, and
its success is measured by wealth, or profit the
business gets.
To be successful in the business finance
function, the three elements are identified:
First, the business entity must obtain money
from the right sources and invest in the right places;
Second, it must continue to attain its purpose
of gaining profits;
Third, cash must be available when it is
needed, and its availability can be crucial in some
decision-making situations.
In corporations, sources of capital are
called…
Shared capital – those invested by
stockholders and;
Loan capital – those provided by creditors
or lenders.
Finance studies money and its management.
Finance as a discipline has three areas which
include financial institutions, investments, and
business finance.
Corporate or business finance studies the
role of the financial manager, his ability to meet
obligations as they come due, identifying the best
sources of funds, allocating the resources among
available investment alternatives.
Finance as an academic discipline has its
roots from accounting and economics. The finance
course emphasizes the analysis of financial
statements and legal, managerial, and marketing
topics. Accounting principles and financial
statements are major sources of information for the
analysis of corporate performance.
Finance courses are generally offered as part
of a program in business, including other disciplines
like information systems, human resource
management, and marketing. However, business
finance can be studied in two dimensions; from the
users of funds perspective, and from the suppliers of
funds perspective.
Business finance involves the management
of financial resources available to organizations. To
operate, a business needs a variety of
assets—tangible and intangible, including plant,
patents, trademarks, and trade names. All these
assets have to be paid for; thus a manager will need
to raise funds.
Corporate finance is concerned with
acquiring, using, and investing funds. Acquisitions
of funds need negotiation with financial institutions
and financial markets, investments involve
allocation of funds, once acquired the manager must
decide its use, because these areas are closely
related, it is impossible to focus on one.
Major financial decisions for the business:
Financial decisions involve generating funds
internally from external sources.
Investment decisions determine the real assets
that a business has.
The managers must also ensure that
investments in current assets – including cash,
inventories, and accounts receivables, are at
appropriate levels throughout the year, such that the
business has sufficient cash to enable payment of its
obligations as they become due.
II. Functions of Business Finance
➢ both an art and science of managing the
financial resources of an organization.
➢ It is concerned with the functions of
allocating the financial resources of the
company, procurement of funds needed, and
the efficient and effective utilization of
funds.
➢ evaluation of the different sources of funds
and the costs involved. Sources available
can be short-term and long-term funds.
Costs of capital may be in the form of
financing charges such as interest, and
service charges, for capital distribution of
owners, costs are the dividends or shares in
the profit of the stockholders.
III. Roles of Financial Managers
Financial Managers have a major role in a
company’s management. This role is essentially the
same in all companies – that is, to acquire the
necessary funds and to ensure that they use the
funds effectively.
In some companies, the financial managers
may not be an independent employee, particularly
for small companies where financial management
may be done by the secretary or accountant.
In larger companies, this function may be
done by executives described as the financial
managers, most of the time, the executive
responsible for the financial management of the
company is also responsible for its accounting
functions.
In larger corporations, the owners or
stockholders are usually not directly involved in
making business decisions, particularly on a
day-to-day basis. Instead, the corporation employs
managers to represent the owner’s interests and Managing the firm’s working capital is a
make decisions on their behalf. day-to-day activity that ensures that the company
has sufficient resources to continue its operations.
The financial management function is
usually associated with a top officer of the firm, Questions as issues are:
such as a Vice-President of Finance or some other
Chief Financial Officer (CFO) ➔ How much cash and inventory should be
kept on hand;
According to Pearson, the top ten major roles of ➔ Should the firm sell on credit – what terms;
Financial Managers are: ➔ Should the firm buy on credit or borrow in
short-term and pay cash.
1. Managing investment in non-current assets
through evaluation of capital projects. IV. Business Organizations
2. Evaluating, obtaining, and servicing
long-term financial requirements through When a business is being organized, one of the first
borrowing, leasing, retaining funds, or decisions that have to be made concerns the form of
issuing stocks and securities. business ownership.
3. Distribution of dividends to shareholders.
4. Collection and custody of cash and Sole proprietorship is a business owned by one
payments of bills. person. This is the simplest type of business to start
5. Managing investment in current assets such and is the least regulated form of organization.
as cash, marketable securities, and
inventory.
6. Obtaining and servicing short-term finance.
7. Managing risks associated with changes in
interest rates and exchange rates.
8. Assessing the viability of growth through
the acquisition of other businesses.
9. Planning the future development of the
business.
10. Development and implementation of
financial policies.

Stephen Ross identified three decisions made by

Financial Managers:

1. Capital budgeting. This concerns the

planning and managing of the firm’s
long-term investments. Financial managers
must be concerned not only with how much
cash they expect to receive but also with
when they expect to receive it and how
likely they are to receive it. Evaluating the
size, timing, and risk of future cash flows is
the essence of capital budgeting.
2. Capital Structuring. This evaluates ways in
which the firm obtains and manages its
long-term investment.
Financial managers’ concerns are:
How much should the firm borrow? What
combination of debt and equity is best? It
determines what part of the pie, or the firm’s cash
flow goes to creditors and what part goes to
shareholders. The officer should decide exactly how
and where to raise money. Corporations borrow
money from a variety of lenders in a number of
different ways, thus choosing among available
creditors and loan types is another significant factor
in financial decisions.
Partnership is an association of two or more
persons who operate a business as co-owners by
voluntary legal agreement.
General Partnership is one in which
partners are liable for the business debts. Partners
share in gains and losses, and all have unlimited
liability for all partnership debts. The way
partnership gains (losses) are divided as described
in the partnership agreement or articles of
partnership.
Limited partnership is composed of partners
whose liability is limited to the amount of capital
contributed, provided the person plays no active
role in the business, or not participating in its
operation.

3. Working Capital Management. This refers

to administration of the firm’s short-term
assets, including inventory, and its
short-term liabilities – such as money owed
to suppliers.

I.
Corporation is a legal entity whose assets and
liabilities are separate from those of its owners. As a
legal person, its personality is distinct from its
owners.
The articles of incorporation must contain a
number of things, including the corporation’s name,
its intended life, its business purpose, and the
number of shares that can be issued, this is
submitted to the Securities and Exchange
Commission for incorporation, together with the
by-laws.
The by-laws are rules describing how the
corporation regulates its existence; how directors
are elected, and what are the functions of each
officer.
II.
Corporate ownership is represented by shares of
stock in the firm. Anyone who holds one or more
shares of a corporation stock is considered a part
owner of the business.
TOPIC 2 - STARTING UP A BUSINESS IN
THE PHILIPPINES
Reasons why people engage into business
1. To increase your income and the level of
control over your income
2. To free up more time for other purposes
3. To gain greater control over your life
Common cause of business failure
1. Failure to understand your market and
customers
2. Opening a business in an industry that isn’t
profitable
3. Failure to understand and communicate
what you are selling
4. Inadequate financing
5. Reactive attitudes
6. Overdependence on a single customer
7. No customer strategy
8. Not knowing when to say “No.”
9. Poor management.
10. No planning
ENTREPRENEURSHIP AND SOUND
BUSINESS IDEA
Entrepreneurship – is the capacity and
willingness to develop, organize, and manage
business venture along with any of its risks in order
to make a profit. The most obvious example of
entrepreneurship is the starting of new businesses.
What is a good business idea?
● Economic opportunity which is within the
reach of the entrepreneur and which will
provide him desirable value.
● An entrepreneur must determine the
soundness of a business before committing
himself financially.
STEPS IN PROMOTING A BUSINESS
1. Get listed - This is one of the most basic
methods of business promotion. List the
business in as many business directories,
yellow pages, and local business websites as
you can find.
2. Contracts – “It’s not what you know, it’s
who you know.” This little phrase holds a
great deal of water in the small-scale
business industry.
3. Your business website – Here’s your
opportunity to show them what you can do,
to tell them exactly how your company can
help them and why they should choose you
over the competition.
4. The almighty business card – Business
card for quick, effective promotion.
5. Advertise – These will vary depending on
where you are and what the local economy
is like, so take some time to research the
various advertising mediums available
before you commit yourself.
6. Free gifts, bribery, and smarm – This
method does take some capital investment to
start with, but can yield good results if it’s
done properly and is correctly targeted.
7. Dealing effectively with the public – Treat
your clients with patience and respect, and
try as hard as you possibly can to make them
happy.
8. Your brand image – The establishment of a
brand is a key factor in any business’
promotional activities. Create a corporate
image for your company, and incorporate it
into all your stationary, documents, and
business website—these techniques echo
professionalism and class.

III. INCORPORATION OF BUSINESS
Classes of Corporations:
1. Stock corporation – are private
corporations that have capital stock divided
into shares and are authorized to distribute
to the holders of such share’s dividends or
allotments of surplus profits.
2. Non-stock corporation – do not issue
stocks such as religious, social, charitable,
civic, or professional organization,
membership org. Like bar or medical
associations etc.
Classifications of Corporations:
1. Profit Corporation – A corporation created
to conduct a business for profit. Thus, it can
distribute profits to shareholders in the form
of dividends.
2. Nonprofit Corporation – A corporation
that is formed to operate charitable
institutions, colleges, universities, and other
not-for-profit entities.
3. Public Corporation – A corporation
formed to meet a specific governmental or
political purpose.
4. Private Corporation – A corporation
formed to conduct privately owned business.
5. Professional Corporation – A corporation
formed by lawyers, doctors, or other
professionals.
6. Publicly Held Corporations – A
corporation that has many shareholders. Its
securities are often traded on national stock
exchanges.
7. Closely Held Corporation – A corporation
owned by one or a few shareholders.
Incorporation Procedures:
Articles of Incorporation – The basic governing
documents of the corporation.
⮚ Must be filed with the SEC.
⮚ Can be amended to contain any provision
that could have been lawfully included in
the original document.
Selecting a Corporate Name – Organizers must
ensure that the name is not already in use and
available.
General-Purpose Clause – A clause often included
in the articles of incorporation that authorizes the
corporation to engage in any activity permitted
corporations by law.
Registered Agent – A person or corporation that is
empowered to accept service of process on behalf of
the corporation.
Corporate By-laws – A detailed set of rules
adopted by the board of directors after the
corporation is incorporated.
⮚ Contains provisions for managing the
business and the affairs of the corporation.
Organizational Meeting – A meeting that must be
held by the initial directors of the corporation after
the articles of incorporation are filed.
Corporate Seal – A design containing the name of
the corporation and the date of incorporation.
⮚ It is imprinted by the corporate secretary
using a metal stamp on certain legal
documents.
Corporate Status – The SEC provides that
corporate existence begins when the articles of
incorporation are filed.
⮚ The filing of the articles of incorporation is
conclusive proof that a corporation exists.
⮚ After that, only the state can challenge the
status of incorporation
⮚ Third parties cannot thereafter challenge the
existence of the corporation.
Components of a Corporation:
1. Corporators – are those who composed the
corporation whether as stockholders or
members. Includes incorporators,
stockholders, or members.
2. Incorporators - stockholders, members
originally forming the corp. and are
signatories of the Articles of Incorporation
that had been filed to the SEC.
3. Stockholders or shareholders – owners of
shares of stocks in a corporation which has
capital stock.
Board of Directors qualifications:
✔ Elected among the holders of stocks
✔ Must own at least one (1) share of capital
stock
✔ Must be resident of the Philippines
✔ Must not have been convicted of an offence
punishable by law.
Express Powers of a Corporation
1. A corporation has the same basic rights to
perform acts and enter into contracts as a
physical person.
2. A corporation’s express powers are found in:
1) Philippine Constitution,
2) SEC,
3) Articles of Incorporation,
4) Bylaws,
5) Resolutions of the board of directors.
Generally, a corporation has the power to:
✔ Purchase, own, lease, sell, mortgage, or
otherwise deal in real and personal property
✔ Make contracts
✔ Lend and borrow money
✔ Incur liabilities
✔ Issue notes, bonds, and other obligations
✔ Invest and reinvest funds
✔ Sue and be sued in its corporate name
Implied Powers of a Corporation
Powers beyond express powers that allow a
corporation to accomplish its corporate purpose.
⮚ E.g., a corporation has the implied power to
open a bank account
⮚ E.g., a corporation has the implied power to
reimburse its employees for expenses.
Winding-up and Liquidation
The process by which a dissolved corporation’s
assets are collected, liquidated, and distributed to:
● Creditors
● Shareholders
● Other claimants
Termination
The ending of a corporation that occurs
only after the:
● Winding-up of the corporation’s affairs
● Liquidation of its assets
● Distribution of the proceeds to the
claimants.
TOPIC 3 - FINANCIAL INSTITUTIONS
➢ the businesses and organizations involved in
the collection and distribution of money.
➢ develop the methods and procedures that
allow them to collect money from depositors
and lend it out to borrowers.
➢ develop the financial securities and provide
the financial markets where lenders,
borrowers, investors, speculators, and
hedgers can exchange money for future
payments in the form of interest, for
ownership interests
This pooled money is then given as loans or as an
investment to businesses and other organizations to
finance specific projects or to provide financing for
other needs. Businesses make money by supplying
products and services that are desirable, and the
more desirable the product or service, the more
money that the business can earn, and, thus, the
greater are the returns on the investments in the
business. Hence, financial institutions are also
financial intermediaries.
Depository and Non-Depository Institutions
Financial institutions act as an intermediary
between savers and borrowers and they direct the
flow of funds between them.
I. Depository Institutions (Banks)
➢ such as banks and credit unions, collect
money from depositors and lend the money
out to debtors.
➢ Borrowers know a lot more about their
ability and willing to pay than lenders do,
which is why it is risky for people to lend
out money directly to others.
II. Depository Institutions (Banks)
➢ mitigate this risk by assessing the
creditworthiness of borrowers for possible
loans, monitoring the borrowers after the
loan, and collecting on delinquent accounts.
➢ which includes commercial banks, savings
and loans, and credit unions, receive money
from depositors to lend out to borrowers.
➢ an accessible payment system. Money can
be transported by check, electronic funds
transfer, or by credit or debit card.
4 important services to the economy:
1. They provided safekeeping services and
liquidity
2. They provide a payment system consisting
of checks and electronic funds transfers
3. They pool the money of many savers and
lend it out to people and businesses
4. They invest in securities
Balance Sheet of Banks
A bank receives money from the deposits of its
customers and from the fees that it charges for its
services, and from borrowing either from other
banks or by selling securities in the financial
markets.
It uses the money to make loans and to buy
securities. A bank profits from the interest rate
spread of what it earns on its assets and what it
paysin liabilities, and from banking fees.
Most of the assets of banks can be grouped into 4
categories:
1. Cash
2. Securities
3. Loans
4. Other assets, which includes real property,
such as equipment, buildings, land, and
repossessed collateral from borrowers who
have defaulted.
Most of bank’s assets are in the forms of loans with
a large portion in securities, since theses are the
main sources of income for a bank.
Cash is obviously an asset to a bank, but it’s an
expensive asset in terms of opportunity cost because
it earns no interest— therefore, banks try to
minimize the amount of cash that they hold.
Loans are the biggest assets of banks. In fact, the
different types of banks can be categorized by the
type of loans that they make. Commercial banks
specialize in loans to businesses, saving and loans
specialize in mortgages, and credit unions specialize
in consumer loans.
Loans can be categorized as:
1. Commercial and industrial loans (C&I),
which are business loans
2. Real estate loans
3. Residential
4. Commercial
5. Home equity
6. Consumer loans
7. Auto loans
 8. Credit card loans
9. Interbank loans
10. Other types
Liabilities - Sources of Funds
Beside owner’s equity, the major source of funds for
a bank is deposits and borrowings, with deposits
being the larger percentage of a bank’s liabilities.
Deposits are the money that the banks customers
place in the bank for safekeeping, to provide
payment services, and to earn interest.
Deposits can be classified as either checkable
deposits or non transaction deposits.
Checkable deposits and Non-transaction
Deposits
Checkable deposits (aka transaction deposits) are
deposits placed in checking account that allow the
depositors to withdraw money at will, write checks,
and transfer funds electronically to and from the
account.
Thus, checkable deposits provide safekeeping,
accounting, and payment services, but pay little or
no interest.
Because depositors can earn more interest
elsewhere and can easily transfer money to their
checking accounts when necessary, they generally
keep only enough in their checking accounts to
maintain the amount of liquidity they need to pay
bills or to have as a source of cash.
Non-transaction deposits are deposits in saving and
time deposits accounts, where withdrawals are
limited. However, since non-transaction deposits do
not provide payment services, the main benefit to
depositors is the interest that they pay.
Banks can pay a lower rate of interest on deposits
because the funds that they hold are guaranteed by
the Federal Deposit Insurance Corporation (FDIC)
up to a certain limit.
Banks also offer time deposits in the form of
certificates of deposits (CDs) that has a specified
term and face value, which is equal to the amount
deposited.
The withdrawal of funds is restricted until the CD
matures. The interest rate on a CD is commensurate
with its term length.
II. Non-Depository Institutions
Non-depository institutions collect money as
premiums, contributions, or by selling securities for
specific purposes, and then invest the money for
higher returns.
a. Insurance companies - pool the premiums
of many people and businesses to protect
each from financial disaster resulting from
rare events.
Insurance companies protect their customers
from the financial distress thatcan be caused
by unforeseen events, such as accidents or
premature death.
They pool the small premiums of the insured
to pay larger claims to those who have
losses. The premium payments are regular
while the losses are irregular, both in timing
and amount.
There are 2 major types of insurance:
property and casualty insurance and life
insurance.
How the premiums are invested depends on
what type of insurance the company offers
which determines the amount.
Property and Casualty Insurance - offers
financial protection against damage or loss to
property or people caused by accidents,natural
disasters, or from the action of others. The most
common type of insurance is auto insurance, since it
is legally required by every driver in every state.
Life Insurance - While the death of a single
individual is an uncertain event, the number of
deaths in a large group is very predictable.
Furthermore, the amount of the claim for any single
death is certain since it is specified in the contract.
There isn’t much of a moral hazard problem in life
insurance because most people want to live and
would not be able to benefit directly from the
proceeds unless it is a whole life policy that also has
a savings portion.
b. Pension Funds - receive contributions from
individuals and/or employers during their
employment to provide a retirement income
for the individuals. Most pension funds are
provided by employers for employees. The
employer may also pay part or all the
contribution, but an employee must work a
minimum number of years to be vested -
qualified to receive benefits of the pension.
Self- employed people can also set up a
pension fund for themselves through
individual retirement accounts (IRAs) or
other types of programs sanctioned by the
federal government.
c. Securities Firms - are companies that
provide institutional support for the buying
and selling of securities. Investment
companies, brokerages, and investment
banks are the major types of securities firms.
Investment companies pool the investments of
many people into a single portfolio that is managed
by professional managers. Investment companies,
such as mutual funds, provide expertises and
economies of scale that small individual investors
would not be able to afford otherwise.
Brokerages provide an institutional framework that
allows retail investors to invest in stocks, bonds,
options, futures, and other financial instruments
directly. Brokers provide trading software that
allows traders to select their trades, and settlement
and clearing services to affect the transactions.
Investment banks help businesses and other
organizations to sell their own stocks and bonds to
the investing public. Investment banks offer advice
to the issuer, register the securities with the
Securities and Exchange Commission, and sell the
securities to their customers.
d. Finance companies - provide loans to
people or businesses using the issuance of
short-term securities, especially commercial
paper, as a source of funds. Consumer
finance companies provide consumer loans
and sometimes mortgages.
They also provide the instant credit offered
by so many retail stores, where the customer
received the item but doesn’t have to pay for
a stipulated amount of time.
Central Banks
Central Banks are financial institutions that have the
most influence over their economies, since they
determine the money supply and key interest rates,
and they regulate and monitor other financial
institutions, specially depository institutions.
As regulators and overseers of the financial
institutions, central banks issue and implement
many banking regulations and require institutions to
have a minimum of capital compared to their
liabilities.
The main function of a central banks is to regulate
the money supply. The money supply must grow
proportionately with the economy.
Central banks are also the fiscal agents of their
countries, providing banking services for the
government. They collect tax receipts and provide
payment services for the government. THey also
issue and retire government securities.
TOPIC 4 - TIME VALUE OF MONEY
How to calculate time value of money:
Let’s say someone would like to buy your car and
they can offer you $15,000 for it today or $15, 500
if they can pay you two years from now. TVM
teaches us that $15,000 today is worth more than
$15,500 in two years.
➔ PV is the present value of money
➔ i is the interest rate or other return that could
be earned
➔ t is the number of years to take into
consideration
➔ n is the number of compounding periods of
interest per year
Using the example above, let’s say you can invest
money from selling the car today for $15,000 in a
CD that pays 2% every year, compounded monthly.
To calculate the value of the money in two years,
here’s how it works:
This means the $15,000 you get for the care today
will be worth $15,612 in two years. If you wait until
two years from now to receive the $15,000
payment, you will lose out on $112 in interest you
could have earned in that time. With investments
that have higher returns, such as stocks or real
estate, the missed opportunities will be even bigger.
Money has time value because of the following
reasons:
1. Risk and Uncertainty
Future is always uncertain and risky. Outflow of
cash is in our control as payments to parties are
made by us. There is no certainty for future cash
inflows. Cash inflows are dependent on our creditor,
bank, etc. As an individual or firm is not certain
about future cash receipts, it prefers receiving cash
now.
2. Inflation
In an inflationary economy, the money received
today, has more purchasing power than the money
to be received in future. In other words, a peso
today represents a greater real purchasing power
than a peso a year after.
3. Consumption
Individuals generally prefer current consumption to
future consumption.
4. Investment opportunities
A sum of money received today, is worth more than
if the same is received after a certain period. For
example, if an individual is given an alternative
either to receive 10,000 Php now or after one year,
he will prefer 10,000 Php now.
This is because, today, he may be able to purchase
more goods with this money than what he is going
to get for the same amount after one year.
We often view interest rates as compensation for
bearing risk. And these risks are:
➔ The possibility that the investor will need to
convert the investment to cash quickly and
will not receive a fair value.
 ➔ The possibility that the investor will need to
convert the investment to cash quickly and
will not receive a fair value

I. Interest

II. Compound Interest

Very few banks today pay interest based on the

simple interest formula.
Instead, they pay interest by using a principle called
compounding.

The difference between simple and compound

interest is this: “Simple interest grows slowly,
compounding speeds up the process.”

Simple interest is interest on the principal amount.

Compound interest is when your principal and any

earned interest both earn interest.
 The important factors related to an amortized loan
are the principal, annual interest rate, the length of
the loan and the monthly payment.

To illustrate, let us chart the history of a loan. Chart

the history of an amot=rtized loan of $1000 for
three months at 12% interest, with a monthly
payment of $340.

But the real challenge is, finding the monthly

amortization cost. Many times, we know the length
of a loan, the annual interest rate and the amount of
the loan.
Can we afford to make the monthly payment? This
question is very important when considering a
mortgage.
The monthly payment formula is basically derived
from the equation future value of annuity = future
value of loan amount.

Thus, monthly payment formula is:

Amortizing a loan

The word amortize comes from the Latin word

admoritz which means “bring to death”.
What we are saying is that we want to bring the
debt to death! Or simply put, RETIRING THE
DEBT.

TOPIC 5 - SHORT-TERM AND LONG-TERM
BUSINESS FINANCING
Financing is a very important part of every
business. Firms often need financing to pay for their
assets, equipment, and other important items.
Financing can be either long-term or short-term.
A company, just like any person, needs to be able to
raise extra funds for itself to build new plants, buy
inventory, etc. But a firm, unlike a person, has many
more options to choose from when it comes to
borrowing money.
People either get a loan from a bank, or use a credit
card, but a firm can raise capital by issuing stock,
selling debt, borrowing from the bank, and even
from other corporations.
There are basically two types of financing:
short-term and long-term.
The primary difference is, of course, how long a
period the extended credit lasts. While the two types
are similar, there are some differences.
Short-term Financing
Short-term financing typically has a duration of one
year or less. But depending upon credit versus
obligations it might be extended for up to three
years.
In general, short-term credit financing is used for
lower amounts and are paid back more quickly.
They tend to have lower risk for the finance
company. The smaller firms you do business tend to
have easy access to short-term financing and often
prefer it.
Sources of Short-Term Financing
There are numerous ways a firm can borrow funds
to satisfy its short-term needs, but the most common
ways are through bank loans, commercial paper,
and banker’s acceptance.
1. Bank Loans
There are two types of bank loans - Secured and
Unsecured. While the main difference is collateral,
there are some other important distinctions as well.
a. Unsecured Bank Loans
An unsecured bank loan is a loan in which the
borrowing firm does not provide any assets as
collateral. Therefore, the bank is taking on default
risk if the borrowing firm doesn’t repay the interest
or principal. These are loans provided by a bank
that can be either committed or non-committed.
With a committed bank loan, usually used if the
firm is borrowing from a bank for the first time, the
firm must file legal paperwork with the bank that
determines the amount the firm can borrow.
A non-committed loan allows the firm the ability to
borrow up to a certain amount of funds, usually up
to the amount previously borrowed, without having
to file the legal paperwork.
b. Secured Bank Loans
A secured loan is a loan in which the borrowing
firm provides assets as collateral. This way the bank
is assured that it will be repaid if the firm defaults
on the loan. Common forms of security, or
collateral, may be inventory, accounts receivable, or
other liquid assets.
A firm would choose a secured loan over an
unsecured loan because the bank will provide a
lower interest rate if the loan has collateral attached
to it. That being said, the firm runs the risk of
having its assets provided as collateral seized in the
case of a loan default.
2. Commercial Paper
Commercial paper is a debt instrument in which a
firm issues a promissory note to a bank, company,
or wealthy individual, which provides fund to the
firm. It typically makes up notes payable in current
liabilities. Commercial paper has a maturity of 270
days or less, which exempts it from being registered
with the SEC, providing an easy transference of
funds.
3. Banker’s Acceptance
A less common way for firms to receive short-term
funds is through banker’s acceptance. This occurs
when a seller sends a bill to the customer’s bank,
which agrees to pay that bill. Of course, the firm
will eventually need to pay the bank back with
interest.
Advantages of Short Term Financing
There are many advantages for the borrower in
taking out a loan for only a brief period of time,
including the following:
1. Shorter time for incurring interest
As short term loans need to be paid off within about
a year, there are lower total interest payments.
Compared to long term loans, the amount of interest
paid is significantly less.
2. Quickly funding time
These loans are considered less risky compared to
long term loans because of a shorter maturity date.
The borrower’s ability to repay a loan is less likely
to change significantly over a short frame of time.
Thus, the borrower can obtain the needed funds
more quickly.
3. Easier to acquire
Short term loans are the lifesavers of smaller
businesses or individuals who suffer from less than
stellar credit scores. The requirements for such
loans are generally easier to meet, in part because
such loans are usually relatively small amounts, as
compared to the amount of money usually borrowed
on a long-term basis.
Disadvantages of Short-Term Financing
The main disadvantage of short-term loans is that
they provide only smaller loan amounts. As the
loans are returned or paid off sooner, they usually
involve small amounts, so that the borrower won’t
be burdened with large monthly payments.
Long-Term Financing
A form of loan that is paid off over an extended
period of time greater than 3 years is termed as a
long-term loan. This time period can be anywhere
between 3-30 years.
Car loans, home loans and certain personal loans
are examples of long-term loans. Long term loans
can be availed to meet any business need like
buying of machinery or any personal need like
owning a house.
Long-term loans are the most popular form of credit
in the financial industry. With the advent of
technology and easy banking, home loans and auto
loans have become a prevalent form of loan.
Features of long-term loans can vary considerably
depending upon the cause for which these loans are
being taken. Long-term loans almost always offer
pre-payment option to customers so that people who
want to pay-off their loan earlier than the stipulated
timeframe do not have to pay continuously for long
tenures.
Sources of Long-Term Financing
Long-term financing is usually needed for acquiring
new equipment, research and development, cash
flow enhancement, and company expansion. Some
of the major methods for long-term financing are
the following:
1. Equity financing
Equity financing includes preferred stocks and
common stocks. The main difference between
preferred and common stock is that preferred stock
gives no voting rights to shareholders while
common stock does
This method is less risky in respect to cash flow
commitments. However, equity financing often
results in dissolution of share ownership and it also
decreases earning. In fact, the foremost objective of
a company is to maximize the value of its equity
shares. Being the owners of the company, they bear
the risk of ownership also.
2. Corporate Bond
A corporate bond is a special kind of bond issued by
any corporation to collect monet effectively in an
aim to expand its business. This term is usually used
for long-term debt instruments that generally have a
maturity date after one year their issue date at the
minimum.
3. Ploughing Back of Profits
Ploughing back of profits is made by transferring a
part of after tax profits to various reserves such as
General Reserve, Reserve Fund, Replacement Fund,
Dividend Equalization Fund etc. Such retained
earnings may be utilized to fulfill the long-term,
medium-term and short-term financial requirements
of the firm.
4. Lease Financing
Lease is a contract between the owner of an asset
and the user of such asset.
Owner of the asset is called ‘Lessor’ and the user is
called ‘Lessee’. Under the lease contract, the owner
of the asset surrenders the right to use the asset to
another party of an agreed period of time for an
agreed consideration called the lease rental.
The lessee pays a fixed rental to the lessor at the
beginning or at the end of a month, quarter, half
year, or year. At the end of the period of lease
contract, the asset reverts back to the lessor, who is
the legal owner of the asset.
Advantages of Long-Term Financing
1. Higher loan amounts
Long-term loans generally come with higher loan
amounts. Hence, home loans, auto-loans, etc. offer
hefty loan amounts as compared to short-term loans
like personal loans. Since, these loans are mostly
secured via collateral submission hence banks are
not apprehensive in lending heavy loan amounts to
long-term loan applicants.
2. Repayment in installments
Repayment of long-term loans generally happens in
equated installments spread over a substantial
period of time. These monthly installments are
generally made up of two components, principal
and interest.
3. Provides long-term support to the
investor for building synergies.
4. Opportunity for equity investors to take
controlling ownership in the the company.
5. Debt diversification for growth and
expansion.
6. Tax Benefits on long-term loans
Tax benefits are applicable on long-term loan
repayment. However this depends upon the type of
loan. For example, an auto loan is a luxury loan and
hence it does not offer any tax rebate whereas home
loan is a loan for the basic need of housing and as
such offers tax exemption on the repayment of loan.
These tax benefits are subject to laws under the
Income Tax Act.
Disadvantage of Long Term Financing
The main disadvantage of long-term loans is that
they incur higher interest rates.
Examples of long-term loans
Long-term loans are loans whose repayment is
spread over a long period of time. This definition
applies to several types of loans. Long-term loans is
just a broad category of loans and is a wide
umbrella which has numerous sub-categories of
loans under it. Listed below are some of the most
prominent examples of long-term loans.
Key Takeaways:
As their names imply, the primary difference
between short-term and long-term business
financing is how long you have to pay back the
loan. Typically, long-term lending options are paid
back over a number of years, while short-term
lending options are paid back over a period of
months or as little as two years.
Your choice of short-term vs long-term financing
will also be determined by:
➔ The amount you need to borrow
➔ How quickly you need the funds
➔ The type of lender you’ll borrow from
➔ The type of collateral you’ll Provide
➔ Your business’ overall financial health.

a. Education Loans
Education loans or student loans are generally
granted for a long period of time especially for
courses like engineering and medical.

b. Home loans
Home laons are one of the most suitable examples
of long-term loans. The tenure for home loans goes
much beyond 3 years and the loan amount is
considerable. Collaterals require to be submitted to
the bank and a guarantor also is required to sign the
loan application.

c. Car loans
Cars are considered as luxurious items and as such
rates offered on these loans are higher than those for
home loans. However, stiff competition among
lending entities have forced banks to lower the rate
of interest for car loans.

d. Personal loans
Personal loans that offer a repayment tenure of
more than 3 years come under the category of
long-term loans. However, even when these loans
are longer in tenure, the rate of interest offered is
not low because personal loans are mostly
unsecured loans and as such borrower does not need
to submit any collateral as security.

e. Small Business Loans

Long-term loans can be availed by both individual
customers as well as companies. For expansion of
business or buying of heavy machinery, business
houses may also require credit in the form of loans.
These loans are known as small business loans.

f. Long-term payday loans

These loans require similar eligibility criteria and
documents that are needed for other types of
long-term loan. These loans are best suited for
urgent financial needs of customers who wish to
pay in small installments over a substantial
repayment period.