Advantages & Disadvantages of Long-Term Financing

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Businesses need capital whether its short-term financing, long-term financing, equity financing or a different form of financing. There are companies out there that focus on expanding their working capital and taking advantage of the credit offered by suppliers and then collecting cash as soon as a sale occurs. Regardless of how you decide to finance your operations, there will be advantages and disadvantages to each. You have to carefully examine the options and figure out which one of the options will be a better fit for your needs.

Stability

If you have long-term financing in place, that means you have stability and no need to search for financing often as compared to short-term financing. It also means that it will be easier to project your earnings and cash flows as you know what your interest expenses will be each month. Short-term financing does not offer those advantages, as you have to constantly renegotiate the terms of your agreement.

Cost of Capital

Having long-term financing in place gives you a better idea of your long-term cost of capital. That way, you are able to better decide which projects are worth pursuing or not. If you don't have long-term financing in place, your cost of capital may change with every negotiation of your terms. That may lead to more confusion in figuring out what kind of profitability you are looking for in a potential project.

Fixed Rate

There some disadvantages to long-term financing. Once you are locked into to a long-term agreement, it may be hard to get out of it. If interest rate drop, you will not be able to renegotiate depending on how you setup your financing agreement. You may setup your agreement in a way that you can prepay if rates drop though. You may also setup a variable rate agreement where your rate changes based on the interest rates. However, that may be very risky as that give you a lot of downside risk if interest rates rise.

Caution

It would not be wise to take on so much debt that you are barely making your monthly interest payments. If you are going to take on debt, take on a healthy amount of debt, not something too high that it will send you into financial distress in a small business downturn. You also want to watch our for your credit rating and how long term financing may impact that. It may increase the costs of you to borrow if the credit rating agencies feel like you are over levering your balance sheet.

References

About the Author

Alex Shadunsky has a bachelor's degree in finance and is pursuing a Master of Business Administration from Indiana University. He has worked at Briefing.com as a junior equity analyst specializing in health-care stocks.

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