Short Term Debt
Short-term debt describes a type of debt in which the borrower is given, at most, a 12 month period repay a debt. An example of short-term debt would be a credit card. Likewise, a long-term debt is a type of debt in which the borrower is given more than 12 months to repay. In long-term debt, permanent assets are relied upon for investment, which may include:
- Current assets
The last 3 decades have seen a shift from long-term debt being the only type of loan that was used for permanent assets to short-term debt financing these type of assets. This shift seems to be due to the fact that the benefits associated with broadening the financial scenario of offering more investment options and freeing cash to pay off long-term debt. Many people disagree with this type financial finagling, arguing that the asset should match the debt term applicably. When writing your research paper on short-term debt, you may want to take up this notion as an ethical question or as a strictly financial quandary. Either way, it makes for an interesting debate in any course.
Short Term Debt and Assets
If you choose to argue against using short-term debt to finance permanent assets, you may want to note that it is important that every firm has sufficient current assets to cover current liabilities. If this does not match, the firm will not have enough cash to be able to cover short-term assets. Furthermore, it is unlikely they will have enough working capital free to meet short-term needs, resulting in cash flows being inconsistent. This makes a nightmare out of cash flow planning and short-term investment funding.
Not matching the life cycle to the debt asset results in the reduction of available working capital as a firm’s urgent financial obligations increase due to the fact that payments are not extended over a long period of time. Resources become limited and creditors view a firm’s ability to repay debt as unlikely or at the very best, questionable. When a firm decides to use short-term debt to finance permanent assets, careful monitoring of debt ratios is certainly necessary to avoid a short-term cash crisis due to the unavailability of liquid assets.