Short-term debt financing is a form of financing that involves financial obligations that have to be resolved within the shortest time possible, usually within two years. This form of financing is very important in the day-to-day operations of a business enterprise or to meet a business’s working capital requirements. Businesses that are either engaged in international trade or those with cyclical operating conditions normally prefer short-term debts as their form of financing. Four types of short-term debt financing are normally available for debt financing purposes. This essay seeks to explain in detail the various types of short-term debt financing available to a corporation and whether these instruments are preferable to that of medium to long-term debt financing. The essay will also list and explain the principal medium to long-term corporate debt instruments the circumstances under which each would be used and for what type of assets. Issues pertaining to the main characteristics that distinguish corporate debt markets from public sector markets. Finally, the essay will explain in detail the alternative types of instruments used to finance the budget deficit and how these may impact certain macroeconomic variables such as money supplies and interest rates. Moreover, the effects of successive surplus budgets on public sector debt markets to money and capital markets will also be enumerated (Debt Financing, 2011, para.1).
Short term debt financing available to corporations and whether they are preferable to that of medium longer term debt financing
Overdraft is a form of debt financing that involves the instant extension of financial credit from a lending institution. This kind of debt financing takes place when a company signs an overdraft arrangement with a bank where it can withdraw cash from its account that exceeds the amount in its account. This form of debt balancing is a revolving type since it does not have a fixed repayment period. The amount of overdraft is determined by the company’s initial agreement with the bank (Debt Financing, 2011, para.1).
The second type of short-term loan is a letter of credit. This is a letter from a buyer to a seller that guarantees that the latter will receive the amount owed to him or her by the former within the stipulated credit period. This form of debt financing can be used in medium and long-term debt financing, especially when a longer credit period is required (Debt Financing, 2011, para.1).
The third form of short-term debt financing is known as a short-term loan. This is an agreement that requires a business enterprise to repay the loan it owes to a financial institution within a year or less. The loan attracts interest. Short-term loans are not revolving in that they have a fixed repayment period. This form of debt financing is used by companies in circumstances when liquidity becomes a great concern to them, especially when they need short-term working capital. This form of debt financing is not applicable in medium and long-term periods (Debt Financing, 2011, para.1).
Bill of exchange is another form of short-term debt financing. It is a document that binds one party to pay a fixed amount of money to another party at a specified future date. This form of debt financing is often used in international trade where importers are granted credit by exporters for goods that have been shipped to them. Because it is tailored for purposes of importation and exportation, it serves a short term rather than long term debt financing (Debt Financing, 2011, para.1).
Medium and long term debt financing available to corporations and the main characteristics that distinguish corporate debt markets from public sector markets
Long term debt financing is used to finance business enterprises that have long repayment periods. The finances from this source may be used to buy assets like machinery that can help the company within five years. Term loan and leasing are the only options available for long-term debt financing.
Term loans are loans that have repayment periods exceeding one year. This type of loan is taken by companies with longer investment or payback plans, for instance, when a factory has to purchase new equipment. Loans are paid through periodic installments. In the case of a mortgage, the borrower has to make periodic installments to repay it. Failure to repay implies the lender can gain ownership of the mortgaged property (Beaney, 2011, para.4).
Leasing gives a company the privilege of using an asset without making payments in full upfront. A lessee agrees to repay periodic rental payments in exchange for using the capital asset. This is a rental agreement. At the end of lease agreement, the lessee can buy the machine at a reduced rate.
Corporate debt markets, as opposed to public debt markets, offer financial solutions that are specifically tailored to attract capital that is needed for expansion of the businesses. These financial debt markets help their clients in leveraging and restructuring financial assets to be able to enjoy continuity, profitability, and growth (Beaney, 2011, para.4).
Types of instruments used to finance budget deficits
Corporate budget deficits can also be financed through sale of stocks. Raising of capital through equity is only possible if the corporation is listed in the stock exchange market. The company has to be in a very sound financial situation for potential buyers to develop an interest in buying its shares. Otherwise, a company whose financing statement only implies bankruptcy cannot raise the requisite amount of money to keep it afloat due to low investor confidence. A company can also contemplate engaging in Initial Public Offer. However, all stakeholders have to consent (Beaney, 2011, para.4).
The effect of a run of successive surplus budgets
A surplus budget implies an increase in public spending. This can spell doom for a country’s economy since it might lead to inflation.
Beaney, S. ( 2011). Defining corporate finance in the UK. Web.
Debt Financing. (2011). Deal Flow Connection. Web.