Page 445 - Business Principles and Management

Unit 5

16.3 Short- and Long-Term Debt Financing

Goals Terms
• Differentiate between short-term • short-term debt • lease
and long-term debt. • line of credit • bond
• Explain the factors that businesses • promissory note • investment bank
should consider when choosing • trade credit • stock option
debt financing.
• long-term debt • venture capital
• Describe several sources from which • term loan
businesses can obtain additional
capital.

Debt Capital

Businesses often borrow capital to expand the business, purchase or construct
new facilities, purchase equipment, pay operating expenses, or replenish inven-
tory. Much of this capital is made available from the savings of individuals.
Millions of people deposit their savings in banks and other financial institu-
tions that lend these funds to businesses. Because a business can borrow money
for just a few days or for many years, debt capital is classified as either short-
term or long-term.

SHORT-TERM DEBT CAPITAL
Short-term debt must be repaid with interest within a year, and often in 30, 60,
or 90 days. Short-term debt capital is usually obtained from a bank or other
lending institution but may be obtained from other businesses as well.

OBTAINING FUNDS FROM BANKS Before lending, banks want to be fairly certain that
the borrowers will repay their loans. The business will need to supply adequate
financial information, and the bank will usually obtain a financial report on the
business from a company such as Dun & Bradstreet. If it is satisfied with the
information and considers the business a good credit risk, the bank will grant a
loan for a specific amount and a set time period. To allow the business flexibility
to choose when to use the borrowed money, the bank may approve a line of
credit. A line of credit is the authorization to borrow up to a maximum amount
for a specified period of time. For example, a business may be allowed a line of
credit up to $150,000 for a year. Whenever it needs to borrow, it may do so up
to the $150,000 limit. Should the business borrow $50,000, it could still borrow
an additional $100,000 during the year.
Another form of debt equity similar to an open line of credit is a business credit
card, often used by small businesses. The credit card is issued by the bank with a set
credit limit. The card can be used to finance purchases as long as the limit is not ex-
ceeded. Both the open line of credit and the credit card carry an interest rate that is
usually lower than similar interest rates charged to consumers for short-term loans

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