Short Term vs. Long Term Financing
Understanding how short-term vs. long-term financing options differ allows you to better manage your company’s strategic goals and finances. Learn more about the differences below.
It also helps understand the importance of long-term partnerships with lenders and find out how short-term financing allows you to stay on the cutting edge of the industry or compensate for uneven cash flow.
On the surface, short-term financing involves committing anywhere from one to five years. This is either for working capital, funds for inventories/trade credit, accounts receivable, uneven business cycles, or short-term leases for equipment that needs to be frequently replaced or is infrequently used.
Meanwhile, long-term financing includes any single financial lease or loan that takes over five years to mature, giving your company more time to realize profits or being more suited towards equipment that tends to last for ten years or more.
There are distinct pros and cons to both. Any given company is sure to need access to a reliable source of short-term and long-term financing to meet their growth goals, scale reliably, and ultimately become successful.
What is Short-Term Financing?
Any lease or loan with a shorter-than-usual repayment period can be considered a form of short-term financing, but it is often a little bit more complicated than that.
What sets short-term financing options apart from long-term ones, aside from term length, is their purpose. While their term limits recognize short-term financing options, their true hallmark is the ability to grant a business a solid leg to stand on during hard times.
Most companies that rely on short-term financing are just starting and need ways to leverage debt to make it to the point where they can begin to spend company money elsewhere. Usually in more long-term investments with a significant, albeit drawn out return.
That being said, there are still a few distinct advantages to using short-term financing to gain funds and equipment, even for established businesses and larger teams.
Short-term financing options exist to provide a great deal of flexibility in a short amount of time. They are usually aimed at helping companies deal with infrequent payments or late-paying customers, seasonal profits (such as helping businesses stay afloat in the off-season, until harvest or the Holidays or some other high revenue event), or to provide financing for a service, good, or piece of equipment that is only needed for a few months or years. Short-term financing options also include taking out a loan to finance inventory and manufacturing costs, to be repaid after a few months.
Let’s go a little more in-depth into the types of short-term financing available to most businesses.
Types of Short-Term Financing
Short-term financing options will often include a handful of the usual suspects, as well as a few niche cases. The most common types of short-term financing include:
- Trade credit.
- Invoice discounting.
- Working capital loans.
- Debt factoring.
- Business-to-business line of credit.
- Certain types of equipment leases (medical equipment, IT, software) and loans (office equipment, amenities, office plants)
What Are the Advantages of Short-Term Financing?
To list a few, the main advantages of short-term financing include:
- Generally lower interest rates.
- Less paperwork, easier to get started.
- Less money involved means less risk and smoother disbursements.
Selecting short-term vs. long-term financing isn’t without its disadvantages.
For one, there is typically a limit on how much you can lease or loan within a minor term because the risk of a larger loan with a short repayment period is too significant.
Secondly, many businesses that end up relying on short-term financing to get them through the season get into the habit of planning with debt – using, spending, and strategizing largely with money they don’t have.
This can be bad for companies just starting with no meaningful credit relationship, as they envelop themselves in a potentially predatory cycle with unknown lenders.
The cycle itself is generally unavoidable for companies seeking short-term financing to grow rapidly, and it’s no secret that larger companies rely on long-term debt cycles to cover for losses and continue to expand at a steady rate. But it’s always important to carefully choose your lending partners.
What is Long-Term Financing?
Long-term financing options represent a much more significant investment, both in terms of time and risk. These are your five-to-ten-year financial plans, your heavy equipment and manufacturing plant loans, your commercial real estate leases, your expansion funds, and more.
Types of Long-Term Financing
Long term financing can come in many shapes and forms, including:
- Equity capital.
- Debentures.
- Term loans with significant length.
- Heavy equipment leases (forklifts, drill rigs, tractors, delivery vehicles, sandblasters, manufacturing equipment) and construction equipment (cement mixers, excavators).
- And more.
What Are the Advantages of Long-Term Financing?
Long-term financing means long-term profits, often with a much greater expected ROI than you’d see with a short-term loan or lease, for both the lender and the lendee. There are more significant sums involved, which means greater risks, but the rewards are plenty.
That being said, there are times where the simple difference between short-term and long-term financing is the useful life of a property or asset. Some buildings or properties can only be leased or financed for a short term, as they rapidly devalue. At the same time, specific equipment is best bought outright or financed over a more extended period than leased for higher monthly costs and no ownership rights.
It’s About the Right Partner
At the end of the day, whether you are in the market for short-term financing options or long-term financing options, you will need the same thing: the right lender.
This could be a bank or another reputable and highly insured financial institution, or it could be a financial group or an investor.
Take your time to find the right people to work with for the right job, and don’t be afraid to shop around – keep in mind what it is you’re primarily looking for (Working capital? Debt factoring? Heavy equipment leases? Inventory loans?) and base your search around it.