3.2 Appropriateness of Short- & Long-Term Finance Flashcards
Define short term finance
= sources of finance that are used for the day-to-day running of a business, typically lasting no longer than one year from the balance sheet date.
It is commonly used to cover revenue expenditure and short-term cash flow problems.
Give 4 examples of short-term finance
• Personal Savings
• Sale of Assets
• Overdrafts – A facility allowing a business to withdraw more money than is in its bank account.
• Trade Credit – Delayed payment agreements with suppliers.
Evaluate short-term finance
✅ Quick access to funds – Ideal for urgent expenses.
✅ No long-term commitment – Reduces financial risk.
✅ Lower overall cost – Often cheaper than long-term loans.
❌ Limited amount available – May not be sufficient for large expenses.
❌ Higher interest rates (in some cases) – Overdrafts can be costly.
❌ Short repayment periods – Can strain cash flow if not managed properly.
Define long-term finance
= sources of finance that extend beyond one year from the balance sheet date,
typically used for capital expenditures such as purchasing machinery, property, or funding business expansion.
State 6 examples of long-term finance
• Share Capital – Raising money through the sale of shares.
• Loan Capital (e.g., Mortgages) – Long-term bank loans secured against property or assets.
• Leasing – Renting assets rather than purchasing them outright. Over a period of time w/ periodic payments.
• Business Angels – Private investors providing funding to start-ups. Provide capital in return for some ownership.
• Microfinance Providers – Small loans offered to entrepreneurs without access to traditional banking
• Crowdfunding – Raising capital from a large number of individuals, each contributing a small amount of money, via online platforms.
Evaluate long-term finance
✅ Suitable for major investments – Used for purchasing fixed assets.
✅ Lower interest rates (in some cases) – Compared to short-term loans.
✅ Allows for business growth and expansion.
❌ Longer repayment periods – Increases financial commitment.
❌ Some sources require collateral – Risk of asset loss if repayments are not made.
❌ May dilute ownership – If raised through share capital.
State 7 factors that affect the choice of finance:
1) size of business
2) purpose of funds
3) amount required
4) cost of finance
5) interest rates
6) external environment
7) duration of finance needed
Describe how the size of a business affects the choice of finance
• Larger businesses have access to more financing options (eg, issuing shares or securing large bank loans)
• Small businesses may struggle to get bank loans due to a lack of credit history or collateral
• Multinational corporations benefit from financial economies of scale, securing lower interest rates
Describe how the purpose (use) of funds affects the choice of finance
• Short-term finance is used for working capital and operational costs, such as wages and inventory purchases.
• Long-term finance is needed for capital expenditure, such as buying machinery, property, or expanding into new markets.
State how the amount required impacts the choice of finance
• Small amounts → Short-term finance (e.g., overdrafts, trade credit).
• Large amounts → Long-term finance (e.g., mortgages, share capital).
• Businesses must ensure they do not over-borrow, as excess debt increases financial risk.
Describe how the cost of finance impacts choice of finance
• Loan Interest – Higher for riskier businesses
• IPO Costs – Expensive due to legal and regulatory fees
• Leasing vs. Buying – Leasing may be more costly over time than outright purchases.
• Overdrafts – Often have higher interest rates than bank loans.
State 3 factors that alter interest rates
- Risk – Higher risk businesses face higher interest rates.
- Time Period – Long-term loans have higher real interest rates due to opportunity cost.
- Economic Expectations – If inflation is expected to rise, interest rates tend to increase.
Describe how external environment impacts choice of finance
• Government Policies
• Economic Conditions: During recessions, banks tighten lending policies and may charge higher interest rates.
• Inflation: Rising inflation reduces the real value of loans, making borrowing less attractive.
Define liquidity
The ability of a business to meet its short-term financial obligations using its current assets.
Define working capital
The difference between a business’s current assets and current liabilities, used to fund its day-to-day operations.
Define collateral
An asset pledged by a borrower to secure a loan, which may be seized by the lender if repayments are not made.
