Long-Term Vs. Short-Term Debit

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    Types

    • Two basic types of financing available for businesses are long-term and short-term debt. Long-term debt is defined as financial obligations that extend beyond one year. Short-term debt is a financial obligation that is scheduled to be fully satisfied or paid off within the course of 12 months.

    Function

    • There is no hard and fast rule regarding how long-term and short-term debt are utilized. However, short-term debt tends to be used to deal with revenue shortfalls impacting day-to-day operations. For example, if a business experiences a slump in sales and is unable to meet payroll obligations, short-term financing is sought.

      Long-term debt tends to be utilized for capital investments. For example, this type of financing may be obtained for the purchase of equipment.

    Features

    • Both long-term and short-term debt can be secured or unsecured. Secured debt is a loan backed by collateral. For example, if a business obtains a loan for an equipment purchase, the lender takes a lien on the equipment itself. If the business defaults on the loan--be it short-term or long-term--the lender is entitled to take possession of the equipment and sell it to attempt to satisfy the balance on the loan.

      Unsecured debt is a loan that is not secured with collateral. In other words, if a business obtains an unsecured loan--short-term or long-term--the lender is not able to seize any collateral (property) to use to attempt to pay off the loan balance.

    Benefits

    • The benefits of short-term and long-term debts include ensuring the ongoing operations of a business enterprise as well as providing a business with the ability to purchase necessary equipment to expand operations and develop markets into the future.

    Warning

    • A business needs to receive professional guidance before making decisions to take on additional long-term or short-term debt. Whether through an in-house financial expert or an external accountant, a business cannot make decisions on acquiring either short- or long-term debt without a close analysis of the positive and negative aspects of assuming additional obligations of these types.

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