ASSIGNMENT

Short Term Financing

Short-term financing means business financing from short-term

sources, which are for less than one year. The same helps the company generate
cash for working of the business and for operating expenses, which is usually for a
smaller amount. It involves developing money by online loans, lines of credit, and
invoice financing.

Example of Short Term Finance

Marry took a loan of $10,000 for six months at the 5% APR (Annual % Rate).
Since the loan is for a shorter period, i.e., less than one year, it will be treated as
short-term finance. After six months, the marriage has to repay the loan amount
and the interest due.

Sources of Short Term Financing

The main sources of short-term financing are:

(1) Trade credit, (2) Commercial bank loans,

(3) Commercial paper, a specific type of promissory note, (4) Secured loans.

1. Trade Credit:
Trade credit has become one of the most common forms of short-
term financing available to business today. For business establishments, it is the
form most often used. When a firm buys supplies or merchandise, the supplier will
generally grant a period of time for the firm to pay for the goods even after it has
already received them. At no explicit interest cost, this is a very attractive means of
obtaining goods.

2.Commercial Bank loans:

Commercial banks lending appears on the balance sheet as
notes payable and is second in importance to trade credit as a source of short-term
 financing. Banks occupy a pivotal position in the short-term and intermediate-term
money markets. As a firm’s financing needs grow, banks are called upon to
provide additional funds. A single loan obtained from a bank by a business firm is
not different in principle from a loan obtained by an individual. The firm signs
a conventional promissory note.

3.Commercial Paper:
Commercial paper is a form of financing which consists of short-
term promissory notes which are unsecured and are sold in the money market.
They are issued by large companies and primarily sold to other business firms,
insurance companies, pension funds, and banks. Because they are unsecured and
are sold in the money market, they are restricted in use to the most credit-worthy of
the large companies.

4. Secured loans
A secured loan is a loan in which the borrower pledges an asset (e.g. a
car or property) as collateral, while an unsecured loan is not secured by an asset. It
is ordinarily better to borrow on an unsecured basis, but frequently a borrower’s
credit rating is not strong enough to justify an unsecured loan. The most common
types of collateral used for short-term credit are accounts receivable and
inventories.

 The main agenda of short-term finance for a business is to get funds for working
capital so that the cycle runs efficiently and the fund does not become a hurdle in
the day-to-day business.
 If the person is unable to repay the loan, it will affect their credit score.

Long Term Financing

Long-term financing means financing by loan or borrowing for more than one year
by issuing equity shares, a form of debt financing, long-term loans, leases, or
bonds. It is usually done for big projects, financing, and company expansion. Such
long-term financing is generally of high amount.
Examples of LTF

 Amazon raised $54 million via the IPO route to meet the long-term funding
needs of the company in 1997.

 Apple raises $6.5 billion in debt via bonds.

Sources of LTF

Some of the long-term sources of finance are:-

1. Equity Shares 2. Preference Shares 3. Debentures

4. Financial Institutions 5. Lease Financing

(1) Equity-Share:
Equity Shares, also known as ordinary shares, represent the ownership
capital in a company. The holders of these shares are the legal owners of the
company. They have unrestricted claim on income and assets of the company and
possess all the voting power in the company.

(2) Preference Shares:

Preference share capital is another source of long-term financing for a
company. As the name suggests, these shares carry preferential rights over equity
shares both regarding the payment of dividend and the return of capital. These
shares carry a fixed rate of dividend and such dividend must be paid in full before
the payment of any dividend on equity shares. Similarly, at the time of liquidation,
the whole of preference capital must be paid before any payment is made to equity
shareholders.

(3) Debentures:
Debentures are one of the frequently used methods by which a
company raises long-term funds. Funds acquired by issue of debentures represent
loans taken by the company and are also known as ‘debt capital’. A debenture is a
 certificate issued by a company under its seal acknowledging a debt due by it to its
holders.

(4) Loans from Financial Institutions:

Financial Institutions are another important source of long-term
finance. In Pakistan, a number of special financial institutions have been
established by the Government at the national level and state level to provide

medium-term and long-term loans to the industrial undertakings.

(5) 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 for 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.

 The company’s management needs to be assured about creating a mix of short-

term and long-term financing sources. More long-term funds may not benefit the
company as it affects the ALM(asset-liability management) position
significantly.
 The company’s credit rating also plays a major role in raising funds via long-term
or short-term means. Hence, improving the company’s credit rating might help the
organizations raise long-term funds at a much cheaper rate