Problems with finance happen very often in every business organization. So, a business manager needs to consider different forms of finance by ensuring the cash coming into the business covers the cash going out.
Effective business managers need to pay careful attention to the cash-flow situation of their businesses to deal with short-term, medium-term and long-term needs for finance.
That is why in a simple way, different sources of business finance are categorized under three categories: short-term finance, medium-term finance and long-term finance.
Here are the following definitions in line with accounting terminology.
Short-term finance
Definition: Short term refers to the time period of less than 12 months – the current fiscal year.
Examples: Examples of external short-term finance include family and friends, overdraft, trade credit, debt factoring and microfinance providers.
Amount: Short-term finance deals with rather small amounts of money.
Purpose: Mainly for Revenue Expenditure. Most short-term finance is used to help a business maintain positive cash flow, and help manage cash-flow problems. It will be used to purchase raw materials, pay wages to production workers, pay trade credit, TAXes, interest on a bank loan, etc.
Medium-term finance
Definition: Medium term refers to the time period of more than 12 months but less than five years.
Examples: Examples of external medium-term finance include hire purchase, leasing and sale-and-leaseback.
Amount: Medium-term finance deals with fairly larger amounts of money.
Purpose: Mainly for lower Capital Expenditure. Most medium-term finance is used to purchase cheaper Fixed Assets such as machinery, equipment, vehicles, etc.
Long-term finance
Definition: Long term, either debt or equity, refers to the time period of more than five years.
Examples: Examples of external long-term finance include long-term bank loans, mortgage and debentures (bonds). Borrowing for long-term means that the business does not expect to repay this debt in less than five years.
Amount: Long-term finance deals with very larger amounts of money.
Purpose: Mainly for higher Capital Expenditure. Most long-term finance is used to purchase expensive Fixed Assets such as land, buildings, assembly lines, etc. The longer the time period, the harder it becomes to plan effectively. Some business activities need huge amounts of money and the business will invest this money over several years, e.g. building a new factory, international expansion, or acquiring or taking over another business.
Different business organizations consider the length of time differently
It is important to remember that these definitions tend to vary between countries, industries and even businesses.
What is important is how these definitions link to the overall business aim and business objectives of the business. Firms that are heavily involved in Research and Development (R&D) such as space technology or pharmaceuticals might view the medium term as 10 years, whereas fast-paced industries such as Information Technology (IT) might see five years as relatively long term.
Therefore, business analysts do not have a common definition for the short-term finance, medium-term finance and long-term finance.
