Comparing and Contrasting Short Term and Long Term Financial Instruments

2FIN652 Managerial Accounting and Finance

Comparing and Contrasting Short Term & long Term Finance for Commercial Entities and Large Public Quoted Companies

Short-Term Finance for Commercial Entities

Generally day to day working capital for a business ideally it should be financed by shorter-term finance facilities such as a bank overdraft, requesting credit facility from suppliers, bank loans and leases. (http://www.conciseaccountancy.com, 2009).

When a business considers a short-term loan, it is usually to cover a period that is less than a year. When a business is considering the appropriate type of short-term finance to suit their requirements they need to consider the following factors.

The maturity and structure of the debt, the rate, cost of arranging and the date for example set up fee and interest rates, flexibility meaning early repayment without penalty, future uncertainties i.e. restrictions on future funding and security requirements.

The report will now address and delve in further detail the different types of short-term finance and detail the cover costs, risks and tax implications for commercial entities.

Bank Overdraft

An overdraft enables a business to maintain a negative balance on its bank account. It represents a very flexible form of borrowing as the size of the overdraft can be increased or decreased almost instantly depending on bank approval. (Attril, P, McLaney, E. 2010).

An overdraft is inexpensive to arrange, another benefit of a bank overdraft compared to a traditional loan is that interest is only calculated on the daily outstanding balance that the firm is overdrawn instead of the full overdraft facility.

An overdraft is extremely useful for businesses, when expenditure in the form of labor; equipment etc. outweighs income from sales and revenue. If the business has an arranged overdraft then they can bridge the gap between any shortfalls of cash, to compensate the wait for a cash injection.

Overdraft facilities do have their disadvantages. The negative balance can be requested on demand by the bank, the interest rate on an overdraft can be quite high, especially for small firms where the risk to the bank is greater. In addition, the business is not allowed to exceed their overdraft limit. If they do the bank might refuse to pay cheques to creditors and will charge for exceeding the limit. (www.bized.co.uk, 2006)

Debt Factoring

Debt factoring is the sale of a business' invoices to a third party. The third party is charged with processing the invoices, and the business lending the invoices is able to receive loans based on the expected payments