finance

Advantages and disadvantages of short-term financing

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The main difference between the three possible financing strategies described above is the
amount of short-term loans used for each of them. Aggressive policy assumes the greatest use of
this source, while the conservative one is the least. The third is in the middle. The use of short-
term credit is generally more risky than long-term, but it has several advantages. Consider the
advantages and disadvantages of short-term loans.
Speed ​​of receipt. Short-term loans can be obtained much faster than long-term loans. When
granting a long-term loan, the lenders try to conduct a detailed study of the financial condition of
the borrower and specify in the loan agreement all the nuances that can occur within 10 or 20
years of using this source. Therefore, if funds are required urgently, they resort to a short-term
loan.
Flexibility. If the need for funds is seasonal and cyclical, then short-term credit is more profitable
for the following reasons:
a) costs associated with obtaining long-term loans and loans are significantly higher than short-
term loans;
b) for non-fulfillment of the terms of the agreement on long-term debt obligations, including
their early repayment, which in principle may be a condition of the contract, provides for larger
penalties than for short-term ones (if the firm assumes that in the near future its needs for funds
will decrease, a loan whose terms can be more flexible);
c) the terms of the long-term loan agreement always contain items that to some extent restrict the
future actions of the borrower firm (short-term loan agreements are less burdensome).
Interest rates. There is a tendency for an abrupt increase in interest rates.
Interest rates on short-term loans are generally lower than for long-term loans. Therefore, short-
term credit will be cheaper than long-term. To get more info, you might need to visit
Credit risk. A short-term loan is cheaper than a long-term loan, but it is more risky. The big risk
is explained by two reasons:
a) if the interest on a long-term loan is relatively stable, then for a short-term it varies widely,
sometimes reaching a very high level. This can lead to bankruptcy of firms that built their
business on the basis of short-term loans;
b) if the firm relies on short-term loans, there may be a situation when it will not be able to return
them when the due date of payments if the creditor refuses to extend the loan term to a more
favorable moment for the company, which will lead to bankruptcy.
It should be recalled that only cash and market securities represent a reliable reserve.
In conclusion, several remarks.
The share of liquid assets and financing are two interrelated aspects of the firm's financial policy.
A firm with a larger share of liquid assets is better able to finance its working capital.
The greater the uncertainty of possible receipts of own funds, the greater the degree of security
of loans should provide for the CFO.
The firm can support a certain degree of securing loans by increasing liquid assets or extending
the terms of financing. In the first case, the funds go to low-income assets, in the second – the
costs of financing grow.
Estimation of the size of the cash deficit is quite complicated. It is easier to calculate the costs as
consequences of the deficit, and then compare them with the alternative cost of raising funds. For
each level of risk, you can choose the least expensive solution.