What are some advantages and disadvantages of short-term versus long-term debt?

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What are some advantages and disadvantages of short-term versus long-term debt?

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What are some advantages and disadvantages of short-term versus long-term debt?

Explanation & AnswerSolution by a verified expert

Explanation

A company can raise funds for its business by debt financing. The debt can be for a short period or a long period. Following are the advantages of short term and long term debt financing.
 
Advantages

Short term

Easy to acquire; The short term finances like short term loans are easy to acquire as it requires less compliance. As the amount involved is smaller there is not a stringent check of the credibility of the borrower.
Resolves liquidity constraints: As these short term loans are available quickly, the company can use it for its day to day business operations. Thus, they enhance the liquidity position.

Longterm

Comparatively Lower interest rates: The interest rate charged by the lender depends upon the amount and the period of the debt. The longer the debt period reduces the regular payments. Thus the interest rate to be paid on each repayment is lower.
Enables funding of bigger projects: An investment in a huge project requires a lot of funds and a lot of time could be spent on saving the required funds. Moreover equity funding would lead to a lot of interference from the stockholders. Thus, issuing a long term debt enables the business to raise a huge amount with limited interference as a fixed amount is provided to the lenders.

 
Disadvantages
 

Short term:

Higher interest rates: The lender would not charge same interest rates for short term as they would have for lonterms. This is because the period is short and the interest amount will be smaller. Thus, short term funds are available at higher costs.
Risk of borrowing cycle: Short Term funds can be easily obtained thus can make a firm regular borrower. Borrowing one more time will be considered to balance your original loan thus leading to a greater number of loans. It would be risky and would cause inefficiency in various business operations.

Long term

Lengthy Process: A financier of long term funds strictly checks the credibility of the borrower. The past performances, the value of assets, purpose of the debt and many more. This process is lengthy and takes a bit of time.
Restrictions on utilisation of funds: The lenders often assess the utilization of the funds by the borrower. The lender may charter the use of funds for high risk projects. Thus, the borrower cannot diversify the funds borrowed.

Verified Answer

The advantages of shortterm and longterm debts are as follows

Short term

Short term funds are available quickly due to limited companies.
It helps to get rid of liquidity problems of the business.

Longterm

The interest rate on long term dates are comparatively lower due to a longer period of debt.
They encourage the business to undertake big projects by providing larger capital.

The disadvantages of long term and short term dates are as follows.

Short term

Due to shorter period and possibility of early repayment, the interest charged by the lender is comparatively higher.
It increases the business risk by affecting the borrowing cycle of the company.

Longterm

The process involved in obtaining a long term debt is very time consuming as a lot of compliances need to be fulfilled.
The lender of the long term debt may restrict the investment of the borrowed funds into high risk projects that may lead to higher profits.

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