Short-term and long-term financing
Businesses need finance for both short- and long-term purposes. In the short term, finance
is required to make regular payments, such as to pay wages, purchases supplies, or pay
electricity and utility bills. These short – term funds are called working capital.
In the long term, finance is required to purchase the major assets on which a business is
based: land, buildings, machinery and other permanent assets.
A distinction is made between short-term (less than one year) and longer-term {over one
year) financing.
Types of short-term financing
 Trade credit: Most businesses buy at least some of their materials and stock on
credit terms from other traders. This gives them a set period of time before they
need to pay for the goods – for example, one month, three months or longer.
 Commercial bank loans: with a commercial bank loan, the bank provides the loan
and the borrower repays the capital over time (with interest), usually in monthly
instalments. Loans are typically taken out over a period of years rather than months.
 Promissory notes: A promissory note is a signed document that contains a written
promise to pay a stated sum at a specific date to a certain person. A business may
use this as an alternative means of borrowing money from someone other than a
bank.
 Instalment credit: Instalment credit is credit granted on the understanding that it
will be repaid at regular Intervals. An example is hire purchase, where the hirer
purchases an item and pays for it in regular instalments. The hirer only owns the
item once he or she has paid the final instalment. The advantage is that the hirer is
able to use the item immediately, then pay for it over time from the time the profits
he or she is able to make from using the item.
 Indigenous credit or private money lenders: These systems of financing are used
when borrowers do not have access to sources of funds from commercial banks. An
example is sou-sou.
 Advances from customers: A business can acquire capital from a customer, who
may pay an initial deposit and then pay instalments prior to the completion of the
work. For example, a furniture maker might ask for up-front payment so it is able to
purchase the materials needed to make the furniture.
 Factoring: A business might need cash to finance its current activities, but has to
wait for its outstanding invoices to be paid. To get around this situation, the invoices
can be sold to a factoring company for less than their face value.
For example, Seaside Enterprises is owed $10,000 through invoices it has issued,
which are due for payment in three months’ time. Seaside Enterprises needs cash to
pay current liabilities. The company therefore sells these invoices to ABC factoring
for $ 9500. ABC factoring then collects the payments when they are due.
 Venture capitalists: These are rich individuals seeking to invest in new business
enterprises. They provide an injection of cash in return for a share in the business.
Venture capitalists are usually able to contribute advice as well as money, as they
are often experienced in the business world. They are also likely to have useful
contracts, such as existing relationships with retailers who may be willing to sell a
new product.
 Crowd funding: This is a new way of raising finance for business that has sprung up
with the growth of the internet and the use of social media. Entrepreneurs can set
out the details of their businesses on a crowd – funding website, in the hope of
attracting funds which can come from all over the world. Members of the “crowd
“may not want a return for their financing, or they may want to receive some form
of benefit.
For example, if a theater company raises funds in this way, then contributors may
expect to receive theatre tickets and feedback on how the company is doing. Crowd
funding can also be promoted through social media sites such as Facebook, where
details of a venture are shared widely on the platform.
 Angel investors: Angel investors are individuals or groups of investors who seek to
invest in businesses that have been set up using the owner’s funds, as well as money
from family and friends. The business wants to expand, but finds it difficult to get a
loan (e.g., from a bank). The business might therefore turn to angel investors who
are wealthy individuals who provide funding for an existing company in return for a
share of the equity of that business. Angel investors typically lend smaller amounts
than venture capitalists but expect to take very high returns of their investment.
Types of long-term financing
Businesses also need to long – term finance, i.e., for periods of more than one year. This
finance will usually be tied up in longer – term assets such as premises, machinery, storage
facilities and transport vehicles. Such finance can be secured from public sector or private
sector lenders.
 Loans from government agencies: Governments often seek to promote small
businesses because they create jobs, sell exports and contribute to effective nation
building. A development bank is a financial government agency that provides loans
for new and growing
businesses if they can prove they have a clear business plan and are likely to
succeed.
Development bank: a financial institution that provides
loans and grants to businesses to help with the process of
economic growth.
Private sector investment and loans: There are a number of ways that small businesses
can access funding and longer – term forms of financial support from the private sector.
Long – term form of
financial support
Mortgage
Description
A mortgage is a loan for the purchase of property or land. If the
borrower fails to make repayments, the lender can take him or her to
court and if necessary, take ownership of the property.
The size of the mortgage depends on the value of the property and
how much is borrowed. A typical mortgage may be a period of up to 25
years, making it one of the longest forms of loans
Debenture
Shares
Insurance
Investment
company
Unit trust
Long-term loans
A debenture is a debt instrument (a piece of paper acknowledging a
debt). The borrower must repay the debt plus interest by a set date.
Debentures are issued for both long – and short – term borrowing, and
by both private and the government.
Documents setting out part-ownership of a business. The shareholder
provides funds to the business in return for regular dividends (a share
of the profits).
Insurance is a form of investment. Insurance companies provide cover
to
businesses against possible losses.
Investment companies pool the investment funds of lots of investors,
which they then lend to businesses.
A unit trust is an example of an investment company. A unit trust is
made up of units of equal shares. An investor can buy one or more
units. A unit trust Invests in companies and sells units representing
these investments to investors. The trust is managed by a professional
fund manager.
In addition to government loans, individuals and businesses can take
out loans for more than one year with a commercial bank. The loan
may be required to be secured by collateral (a secured loan) or
without security (an unsecured loan),
A customer may have to pay more interest on an unsecured loan than
they have to pay on a secured loan.
Home – work
1. A small business wants to expand, but it has already exhausted the use of funds from
the owner’s capital and from family and friends, and it is not able to secure a bank loan.
Explain one way the business could secure additional funding.
2. Identify two financial institutions that might provide long – term financed for a
business. What types of finance do these institutions provide, and how would this help a
growing business?