Short-term and long-term financing
GREETINGS. ONCE again, it is time to focus on another aspect of principles of business. This week, we will discuss short-term and long-term financing.
Different forms of businesses raise their capital in different ways. Many businesses raise their capital through loans. They may raise this loan capital on a short-term basis or on a longterm basis by borrowing from the financial market. The money market and the capital market are under the financial market.
THE MONEY MARKET
The money market is a market where firms, individuals or the government can get money to borrow on a short-term basis. Short term refers to up to one year. Medium term is two to five years. Although the money market is used mainly by everyday consumers who want to buy consumer durables such as furniture and cars, businesses also want short-term financing. These shortterm funds are usually for businesses to run their day-to-day operations, including payment of wages to employees, inventory ordering and supplies. For example, a firm may place an order for raw materials, pay for it with finance and anticipate covering this finance by selling these goods over the period of a year.
Many methods (sources) are open to firms to seek short-term financing. These include: Overdrafts Short-term loans Bills of exchange Promissory notes Letters of credit Inventory loan Treasury bills
Commercial paper
The institutions involved in giving shortterm loans include:
Commercial banks: Give loans to purchase assets such as cars, household appliances, vacations, etc.
Merchant banks: Provide short-term capital to importers and exporters in the form of letters of credit, e.g., Capital and Credit Merchant Bank.
Finance houses: These provide credit for hire purchase and other kinds of installment credit. They acquire funds from shareholders or from commercial banks, e.g., Industrial Finance Company.
Credit unions: Loans are given to only members who have share capital. Loans are given up to three times share capital and interest on loans is relatively low.
Partner hand: An individual receives a loan or advance when he receives the entire ‘hand’ or ‘draw’, unless he receives the final or last ‘hand’ or ‘draw’.
Discount houses: Treasury bills, bills of exchange and other short-term securities are bought and sold by discount houses, e.g., The Warehouse. A security is discounted when it is bought for less than its face value. When the security matures, the face value is given to the new owner of the security who will make interest, which is the total of the difference between the buying and selling price of the security.
THE CAPITAL MARKET
When a loan is repayable between five and 30 or so years, it is obtained under the capital market. The rate of interest in the capital market is much lower than in the money market. The capital market trades in securities with a lifespan of more than one year. These include: Bonds Stocks Shares Fixed deposits Term deposits
The institutions involved in giving loans on a long-term basis include:
Commercial banks
Merchant banks
You will notice that commercial banks and merchant banks are involved in both short-term and long-term financing.
Insurance companies: Lend money to their clients directly and have policies wherein their clients can borrow money from these policies and pay back over a long period of time.
Unit trusts
Investment trusts
Development banks. For example, the Caribbean Development Bank and the Inter-American Development Bank. These give loans for the improvement of particular sectors of an economy or for certain infrastructure so that economic development can take place.
Building societies: Loans are available for up to 30 years to build on own land, purchase home on the open market, buy land or for home improvement. These loans are referred to as mortgages.
Government agencies. For example, the Jamaica Industrial Development Corporation.
You can do some research on unit trusts and investment trusts so that you can have an idea of the type of loans they give.
The capital market is used by governments because it allows them to borrow large sums of money for long periods of time. Governments borrow from the International Monetary Fund, the World Bank, the European Union and developments banks.
We considered personal savings when we looked at personal budgeting. Next week, we will look at investment and the connection between savings and investment. Do take care until then.