Short and Long Term Finance

Short Term Finance

Trade Credit: This is when suppliers allow goods to be purchased on credit for later payment. It can be a cost-effective form of finance as long as the terms of the agreement are met - usually payment within 30-90 days.
Overdraft: Banks may permit businesses to withdraw money in excess of the account balance, up to a certain defined limit. An overdraft is usually payable on demand and can be useful when cash flow is unpredictable.
Factoring: Businesses can sell their accounts receivable (invoices) to a third party in order to receive immediate payment. This can improve cash flow, but businesses must bear in mind the cost of the factoring service which is a percentage of the total debt sold.
Short-term Loan: Banks or other financial institutions provide a fixed amount of money which is repaid in less than one year, usually with interest. This can be useful for covering immediate costs.

Long Term Finance

Issue of Shares: In exchange for an investment in the company, a share represents a unit of ownership in a company. Limited companies can sell shares to raise finance. It should be noted that selling shares will dilute current owners’ shares of the business, but it does not have to be repaid like a loan.
Bonds and Debentures: These are long-term loans to a company by investors. Unlike shares, bond and debenture holders do not gain ownership in the company, but they do receive periodical interest payments and the return of the principal amount at the end of the term.
Long-term Loans: Provided by banks or other financial institutions, these loans have to be repaid over an extended period (usually over one year) with added interest. They are typically used for investment in assets or significant expansion plans.
Leasing and Hire Purchase: Leasing does not provide ownership to the lessee, whereas, in hire purchase, the ownership is transferred after the last instalment is paid. Both methods allow businesses to use expensive equipment without a large upfront payment.
Grants: These are funds provided by government or non-governmental organisations which do not require repayment. They are usually reserved for specific projects or sectors and can be a valuable source of funding for eligible businesses.
Venture Capital: This is a substantial investment by individuals or firms in businesses with high growth and profit potential, in return for equity. It is a significant source of capital for start-ups with innovative ideas.

Comparing Short and Long Term Finance

Interest Rates and Cost of capital: Short-term finance usually has higher interest rates than long-term finance. However, the total interest paid may be less due to shorter repayment period.
Risk: Short-term finance usually poses less risk to the creditor, as it is to be repaid sooner. However, it may pose more risk to the business, especially if it relies on renewable short-term finance.
Flexibility: Short-term finance typically provides more flexibility as it can be arranged and repaid quickly. However, long-term finance may provide more stability for strategic planning.
The Role of Cash Flow: Businesses with more stable cash flow can more safely rely on short-term finance, while those with less predictable cash flow may prefer the stability of long-term finance.