How Corporations Pay Short-Term Debt
Short-term debt is a term used to describe any liabilities that are due within a year. This leaves long-term debt a wide definition, from just over 12 months to 30 years or more. But from an accounting perspective, defining short-term debt within such a brief window is very useful, because it can be these debts that a business most struggles to pay. Long-term debts tend to have more reasonable payment schedules that can be paid with interest and slow returns from investment, but short-term debts require the immediate interest of the business. Businesses use several methods to pay off short-term debt.
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Cash
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The easiest way to pay short-term debt is through cash. In this situation, a debt comes due and the company pays it from a cash account, where money is stored for just such a purpose. However, many companies prefer to use their cash for other purposes. Investors often view corporations with a large amount of cash with suspicion, as cash can be best used in investments, where it can make greater returns. But in some industries, using cash to pay off frequent short-term debts is very common.
Accounts Payable
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If a business does not pay short-term debts with cash, they transfer them to an accounts payable account, where they are considered a liability by the business and must be dealt with in the future. Most businesses have some type of accounts payable system to gather and collate their debts. This makes it far easier for accountants to manage business debt and view what debts must be quickly paid off. For instance, businesses in relationships with suppliers often have accounts payable systems to channel the month-to-month debt incurred by ordering new supplies.
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Lines of Credit
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Lines of credit are a common way for businesses to take care of short-term debt without using cash or straining resources. A line of credit is an account with a lender, usually a large bank. The account has a maximum debt limit and allows the corporation to borrow money at any time, up to this maximum. The bank then requires repayment and may charge a higher interest rate if payments are not made on time, like a credit card. Businesses use the line of credit to pay off debts in accounts payable, then arrange payment with the bank at the end of every month.
Liquidating Assets
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If businesses have a high amount of short-term debts and not enough money to pay them all off, it may resort to liquidating assets. This usually means selling investments or even physical assets to take care of the debts coming due. Corporations try to avoid liquidating assets only to pay off debts. It can be a dangerous decision, and is often the precursor to more serious problems like insolvency and eventual failure.
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