Long-term and short-term finance - class-XI

Retained Earnings

True.

Companies develop short-term financial plans to meet budget and investment goals within one fiscal year. These plans have a higher degree of certainty compared to long-term plans. Short-term plans often are amended as financial and investment goals change. Businesses and individuals alike use short-term plans to manage short-term cash deficits

The issue of preference shares does not restrict the company's borrowing power, at least in the sense that preference share capital is not secured against assets in the business.

1. Short term loans are available quickly. One of the defining features of short term loans is that you can borrow them fast – sometimes even on the same day or within 24 hours. This makes financing, such as payday loans, ideal if you find yourself in a situation where you need cash fast.
   
2. There is no longer term commitment with this type of loan. With short term loans you only need to focus on the immediate future as the loan is paid off within a much shorter space of time. Many people find it intimidating to commit to borrowing over a period of many years, worrying about making the payments and managing the loan with all of life going on around. With short term loans this isn’t an issue as repayment terms can be as short as a month, leaving you free to repay and move on.
   
3. Short term loans could cost less. The longer you borrow for, the more interest you will pay. Short term loans offer a simple way to borrow the cash you need and to pay less for it – the shorter the term over which you borrow the money, the less interest you will pay. As you have not secured your home or car with short term borrowing there is also less risk of losing them if you cannot make repayments. While you should always make sure that you only borrow what you can afford to repay, avoiding the risk to your home or car that some longer term loans create can take the pressure off for many people.
   

Personal assets pledged by a borrower as security for a loan are known as collateral. Business borrowers may use equipment or accounts receivable to secure a loan, while individual debtors often pledge savings, a vehicle or a home as collateral. Applications for a secured loan are looked upon more favorably than those for an unsecured loan, because the lender can collect the asset should the borrower stop making loan payments. Banks measure collateral quantitatively by its value and qualitatively by its perceived ease of liquidation.

A long term investment decision is also called a capital budgeting decision. It involves committing the finance on a long term basis, e.g. making investment in a new machine to replace an existing one or acquiring a new fixed assets or opening a new branch etc.

Unsecured loan is a loan that is issued and supported only by the borrower's creditworthiness, rather than by any type of collateral. Because unsecured loans, sometimes referred to as signature loans or personal loans, are obtained without the use of property as collateral, the terms of such loans, including approval and receipt, are most often contingent on the borrower's credit score. Borrowers must generally have high credit ratings to be approved for certain unsecured loans.

Therefore short term loans are issued on the basis of creditworthiness not on the basis of collateral security hence short term loan are unsecured.

The retained earnings of a corporation is the accumulated net income of the corporation that is retained by the corporation at a particular point of time, such as at the end of the reporting period. Retained earnings are the profits that a company has earned to date, less any dividends or other distributions paid to investors.

The short-term financial needs of the companies are generally met from the following sources:

1. Trade Credit.
2. Consumer Credit.
3. Installment Credit.
4. Account Receivable Financing.
5. Bank Credit

Many lenders will advertise a low interest rate but will have a huge application fee, valuation fee, documentation fee or commitment fee attached to the loan which ends up making it very expensive. Many lenders will promise that they can fund within a short period of time but end up pushing back deadlines and blame the client when in fact they have never been able to do what they promised.

Inadequate working capital may be the major causes for closing down the business organization. Due to shortage of working capital, raw materials can not be purchased on time and payment of labor and other expenses can not be made on time. Due to this companies financial reputation will go down and on the same time business cannot run properly.

Equity finance is a method of raising fresh capital by selling shares of the company to public, institutional investors, or financial institutions. The people who buy shares are referred to as shareholders of the company because they have received ownership interest in the company. It is one of sources of the long term financing.

Businesses should generally follow the rule of tying the length of their financing to the life of the asset they are financing. So, if a business needs to make a major capital improvement, such as purchasing a piece of equipment for their manufacturing process that will last 10 years, a long-term business loan would be the appropriate type of financing. A short-term business loan would not be appropriate in this case. If a business needs to buy capital equipment, buildings, other businesses, or undertake construction projects, a long-term loan is the way to go.

Inventories are categorized based on their purpose and management strategy, including safety stock (to handle demand variability) and normal/cycle inventory (for regular operations).

Preference Share is the Costliest Long - term Source of Finance. The costliest long term source of finance is Preference share capital or preferred stock capital. It is the source of the finance. When it is compared to other source of long term sources.

One of the important decisions under
financial management relates to the
financing pattern or the proportion of
the use of different sources in raising
funds.

Financial management, among others, involves decision about the proportion of long-term and short term funds. An organisation wanting to have more liquid assets would raise relatively more amount on a long-term basis. There is a choice between liquidity and profitability. The underlying assumption here is that current liabilities cost less than long term liabilities.

A business cannot function smoothly unless it has adequate funds are made available to them. The need of funds arises from the stage when an entrepreneur decides to start a business. The factors affecting the choice of sources of funds are the cost that it will incur to raise funds, the purpose and the duration for which the funds are to be raised and the risk that a company has to bear to raise those funds.

There
are two types of cost that should be taken into account while
deciding about the source of funds to be used for an organization. The two types of cost include explicit and implicit cost of the organization.

The financial strength of a business is a key determinant as finance is the life blood of any business. Finances are required by a company to carry out various activities. They can be classified into long-term capital needs and working capital needs.

Short term borrowings offer the benefit of reduced cost due to reduction of idle capital. Short term borrowings refers to the debt which is obtained for an year or less than a year.

Long-term borrowings are generally used for fixed capital needs like plant & machinery, buildings and projects. They are borrowings which exceed 5 years or more. Hence, long-term borrowings are considered a necessity on many grounds.