Difference Between Long-Term & Short Term Sources of Financing

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As businesses address the need to meet payroll obligations, inventory purchases and expansion, they frequently make use of a variety of financing sources. Most sources of financing fall into either the short-term or long-term categories. The time variances between when a source extends credit and calls for payment serve as the principal difference between the sources of financing.

Short-Term Sources

  • Businesses can take advantage of a wide range of short-term financing sources. Banks offer short-term loans, and the business can often arrange for overdraft protection. Overdraft protection addresses the issue of time gaps between purchases and sales. Vendors often supply businesses with inventory on trade credit, meaning the business receives the goods and gets a window of time before the bill comes due. In essence, the vendor offers the business time to sell the inventory and cover the bill from the sales. The business can also use credit cards, either issued to the owner or to the business, to cover short-term costs. Factoring lets a business raise capital by selling its outstanding invoices for a percentage of their current value.

Long-Term Sources

  • Long-term financing sources are scarcer than short-term sources, as the lender needs a significant cash reserve to sustain the loan. Banks provide long-term loans, but the loan process involves deep scrutiny of the borrower’s financial situation. Angel investors and venture capitalists invest in promising businesses with the expectation that it can require several years before a business becomes profitable. The Small Business Administration can facilitate a business loan, though it does not loan directly. Local economic development organizations sometimes offer additional loans, if a business can secure a traditional loan from a bank.

Primary Difference

  • Short-term sources of credit trend toward the very near term, generally 12 months or less. Trade credit, for example, typically ranges between and 30 and 90 days. Banks do offer intermediate loans up to three years, but this leans much closer to the short term. Long-term business loans from a bank often carry repayment terms of 10 or 20 years. Venture capitalists and angel investors also invest on a long-term horizon, though the precise length of time varies based on the success of the business and the terms of any exit strategy. In general, venture capitalists and angel investors expect a faster return on investment than a bank extending a long-term loan.

Costs

  • The relative costs of both short-term and long-term financing present another salient difference. Partnering with a venture capitalist or angel investor, for example, requires the ceding partial ownership of the business. Venture capitalists also require a say in the decision-making process. Short-term sources of financing, such as bank overdrafts and credit cards, frequently include very high interest rates compared with long-term loans.

References

  • Photo Credit shironosov/iStock/Getty Images
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