In this Blogpost, we will talk about the Long Term and Short Term Sources of Finance which includes-
(i) Meaning of Short term Sources of Finance (ii) Meaning of Long term Sources of Finance (iii) Advantages and Disadvantages of Long term Sources of Finance (iv) Advantages and Disadvantages of Short term Sources of Finance (v) Examples of various Long term and Short term Sources of Finance (vi) Difference between Long term and Short term Sources of Finance (vii) Conclusion of Short Term and Long Term Sources of Finance.
Today In this Modern Era, so many Youngster Minds are coming with their Unique Business Ideas. But As You know To Scale Every Business, funds are the key factor. It is required from the Incorporation of Business to the Production, Advertising, Launching of Product and never ends.
These Never-Ending funds are taken for some particular time, needs etc. But, all the Various Sources of Finance are mainly categorized into two types- Short Term and Long Term Sources of Finance.
Meaning of Short Term Sources of Finance
Short Term Sources of Finance is the credit facility given to the firm for less than one year and it includes all the operating expenses which are required for the day to day activities.
It is the credit arrangement given to the enterprises so that to build the gap between their short term expenses and income. Any Delay in getting the Short term Funds may stop the operational activities of the Business.
Short Term Finance Sources helps the enterprise to smoothly manage their day to day activities. That’s why Short Term Financing is also known as the Working Capital Requirement.
Advantages and Disadvantages of Short term Sources of Finance
- Gets Fast Approval- The First Advantage of Short term Financing is that it easily get approved from the lenders within hours. Sometimes, the funds are approved under one Business Day. But the key point is that it gets quickly approved.
- Less Interest- More the Money lends for the finance, more interest the firm has to pay. However, In Short-Term Finance, the firm has to pay less interest because of the less money involved.
- Helps in improving the Credit Rating- Short Term Financing Sources have the benefit of choosing these loans that suits their personal circumstances. These type of finance can be easily paid off by the firms which help in improving their credit rating. If Any Firm has the Bad Credit History of loans, they can easily improve that from short-term finance.
- Offers Flexibility and Reduce the Stress- Short-Term Financing provides flexibility and reduces the stress of the firms. Now, Firms can easily apply for these type of sources any time without any stress because of less interest and easy availability.
- High-Cost Loans- Typically in the Short-term Loans, you have to pay the high monthly payment. This may end by paying more amount of money by the firm to the lenders.
- Negative Impact on Credit Score- As Short term Loans helps to improve the Credit score. But If You are not able to pay off these loans, it can also put the negative impact on the credit score of the firms.
- Fall into the cycle of Borrowing- The Flexibility, Easy Availability of the Short-term Sources of Finance makes you the habit of borrowing finance. Whether You need finance or not, it makes you spend more money than you can afford.
Meaning of Long Term Sources of Finance
Long-term Financing plays an important role in financial management for every firm. It is defined as the credit facility given to the firm for more than 5 years.
Long-term Sources of Finance are required for firms to manage their Long-term Liabilities. It comprises of financing the fixed capital required for the investment in fixed assets.
It involves the financing decisions for the long periods of time that also has more risk. That’s why Long-term Sources of Finance is also known as the Capital Budgeting Decisions.
Advantages and Disadvantages of Long-term Sources of Finance
- Least Costly- Long-term Financing is less costly because it involves the less return and also the interest on the debt is tax-deductible.
- Enjoy Tax Savings- In this, the company also enjoys the tax benefits on the interest paid to the creditors.
- No Interference in Business Operations- The Main Advantage of Long-term Sources of Finance is that Creditors have no right to interfere in the operations of the business and also don’t have voting rights like the equity shareholders.
- Permanent Burden to the Firm- Long-term Debt makes the permanent burden for the company by paying the interest rates for a long time. Whether the Company earns the profit or not, the firm has to pay the interest otherwise the creditors can claim on their assets.
- Comprises of the Restrictive Agreement- In the Case of Debentures, it comprises of the restrictive agreements which put the effect on the flexibility of the operation of the Business.
- It has the Fixed Maturity Date.
- It is also the Riskiest Source because the Company has to pay the interest to the Creditors at the fixed time. Non-payment of interest can lead to bankruptcy for the firm.
Examples of Long-term and Short-term Sources of Finance
Examples of Short-term Sources of Finance are as follows-
- Indigenous Bankers- Indigenous Bankers is the oldest form of short-term financing. It is also known as Private Lenders. These types of Lenders lend the money at a higher rate of interest to the Buyer compared to the other lending banks.
- Trade Credit- Trade Credit is the extend rate of Credit by the Suppliers to the Buyer. When the Buyer is not able to pay the money under the payment period as per the sales invoice, then the firm has to pay the penalty amount.
- Instalment Credit- Installment Credit is the most popular form of Short Term Sources of Finance. In this, assets and possession are taken immediately, but the money is paid in the form of instalments for a specified period of time. For Example- Buying Bike, Mobilephones on Installments.
- Advances– In this, the Buyer has to pay the amount of the product before getting the possession. Advances are used for tailor-made products which are prepared according to the requirement of the buyer. For Example- Tailormade Network Marketing Software designed for the Network Marketing Company.
- Factory Agency- Factoring is a financial institution which provides the services relating to the management of finance. It is offered by the Commercial Banks and factors agencies. In this source, the Commercial Bank provides finance by discounting the Bill. By this, the Firm gets the immediate payment for the sales.
- Accrued Expenses- Accrued expenses are those expenses which have been incurred but not yet paid. The Common Examples of Accrued Expenses are Outstanding Rent, Salaries etc.
- Deferred Income- Deferred Income is known as Unearned Revenue. In this, the company receives the advance for the products and services that are to be delivered in future. For Example- Netflix Subscription, Gym Subscription etc.
- Commercial Papers- It is an unsecured Promissory Notes issued by the firms to increase the short-term loans. In India, those Companies can use Commercial Papers who have the Good High Credit Rating and Sound Financial Health.
- Commercial Banks- Commercial Banks provides loans, deposits, overdraft and many more facilities to the Firms. Some of the Examples of the popular Commercial Banks in India are ICICI Bank, HDFC Bank, IDBI Bank and lot more.
- Public Deposits- Public Deposits refers to the acceptance of the fixed deposits from the public to finance the working capital needs. Most of the times the Companies who want Public Deposits do the advertisement in the newspapers.
The Examples of Long-term Sources of Finance are-
Equity shares are one of the common examples of Long-term Finance Sources. They are also known as the Owners of the Company. These Shareholders receive the dividend after giving the payment of interest and dividend to the preference shareholders.
Features of Equity Shares-
(i) No Maturity Period- Equity Shares don’t have the maturity period. These Shareholders receive the dividend until the winding up of the company.
(ii) Equity Shares can also claim on assets at the winding of the company.
(iii) Equity Shareholders also have voting rights to participate in Meetings of the Company.
(iv) Pre-Emptive Right- One More Right Equity Shareholders have is the Preemptive Right. In this right, if the Public Company proposes to increase the subscribed capital by the allotment of the shares after 2 years or the expiry of one year whenever it is earlier. Then, these shares will be offered first to the existing shareholders.
This is the Second Long-term Source of Finance. As the name shows, Preference Shares got more preference than the Equity Shares. Preference Shareholders got the preference in getting the Dividends and claim on capital in case of liquidation before the Equity Shareholders.
Types of Preference Shares
(i) Cumulative and Non-Cumulative Preference Shares- Cumulative Preference Shares are those shareholders who have the right to get the accumulated dividends of the previous year along with the current year. Non-Cumulative Preference Shares have no such right.
(ii) Redeemable and Irredeemable Preference Shares- Redeemable Preference Shares have a fixed maturity period. These types of shares get their subscribed capital or redeemed after a specific period of time. But the Irredeemable Preference Shares don’t have such rights.
(iii) Participating and Non-Participating Preference Shares- Participating Preference Shares are those preference shareholders who can participate in the extra profits in the case if some profits are left out after giving the dividend to the equity shareholders. But Non-Participating Shares don’t have such rights.
(iv) Convertible and Non-Convertible Preference Shares- Convertible Preference Shares are those shareholders who can convert their shares into the Equity Shareholders after a particular period of time. But Non-Convertible Preference Shares don’t have such rights.
Characteristics of Preference Shares-
(i) Except for the Redeemable Preference Shares, all the Preference Shares have the no Maturity Period.
(ii) Preference Shareholders have the preference to get the dividend before the Equity Shareholders.
(iii) At the time of winding up of the company, Preference Shareholders also have the preference in getting the claim on assets before the Equity Shareholders.
(iv) Preference Shares don’t have voting rights to participate in the company meetings.
(v) They also get the Hybrid form of Security because they get both the benefits of Debentures as well as Equity Shares by getting dividends at a fixed rate.
Debentures are the popular Long-term Finance source. It is an acknowledgement of Debt. A debenture is a document under the seal of the company which provides for the payment of the principal amount as well as interest thereon at a fixed period of time. It is usually secured by fixed or floating charges on the company’s property.
Types of Debentures-
(i) Secured and Unsecured Debentures- Secured Debentures are those debentures who can claim against the company if they don’t get the interest on the time. But Unsecured Debentures don’t have these rights.
(ii) Registered and Bearer Debentures- Registered Debentures are those debentures which are registered on the name of any person and To transfer the Bearer Debentures, both the transfers and transferee have to sign the transfer brochure. But the Bearer Debentures are easily transferable and negotiable.
(iii) Redeemable and Irredeemable Debentures– Redeemable Debentures are those debentures who have a fixed maturity period and they get their paid capital after a fixed period of time. But the Irredeemable Debentures don’t have these rights.
(iv) Convertible and Non-Convertible Debentures- Convertible Debentures are also known as Zero Interest Bond. These types of Debentures convert into equity shares after a specific period of time. But Non-Convertible Debentures can’t convert into equity shares.
After giving the Dividends to the Equity Shareholders whatever profit is being left out, from that some part of the profit is retained for the future. That money is known as the Retained Earnings.
Financial Institutions is also the popular Long-term Source of Finance. Some of the Financial Institutions are IDBI Bank, ICICI Bank, SIDBI Bank etc.
Difference between Long-term and Short-term Sources of Finance
|Basis of Difference||Long-term Finance||Short-term Finance|
|Meaning||It refers to the financing for the business that involves longer time to repay the loan.||It refers to the financing for the business that involves the shorter time span to repay the loan.|
|Flexibility||Long-term Finance is less flexible than the other finances because the finance of this source can not be changed as per requirement.||Short-term Finance is more flexible because the the amount of funds can be changed as per the requirement.|
|Security||It requires the collateral security or specific assets.||It doesn't require the collateral security.|
|Restrictive||These Sources are more restrictive comprises of the restrictive provisions in case of debentures.||These sources are less restrictive than the other sources.|
|Risk Involvement||These type of sources are less riskier than the other sources because of stable interest rate and less temporary recession.||These type of sources are more riskier because of not stable interest rate and temporary recession may lead to the bankcruptcy.|
|Also known as||It is also known as the Capital Budgeting Decisions.||It is also known as the Working Capital Requirement.|
|Finance Limit||For these type of sources, companies can avail large amount of finance.||In these sources, companies can raise limited number of funds.|
Conclusion of the Long-term and Short-Term Sources of Finance
So, this was about the Long-term and Short-term Sources of Finance. Both these Sources of Finance plays an important role in Business. On one side, Short-Term Sources of Finance helps in managing the working capital of the Business.
On the Other side, Long-Term Sources of Finance helps in providing the fixed capital for the investment in the fixed assets. The organization should make the balance of both these sources for smooth operations of the business.