A company that uses debt to finance its business can engage in either short-term or long-term borrowing. Short-term borrowing involves loans with a maturity of one year or less. It is used to cover current cash needs, such as financing growth, seasonal cash flow needs, and major customer orders. The loans in this category are often called working capital loans, because that is what they finance.

Long-term loans have maturities of longer than one year. Companies borrow long-term to finance major capital expansions, research and development projects with longer time horizons, and real estate.Short-Term Debt

There are a number of types of both short- and long-term debt, and a number of related elements. We first cover those having to do with short-term debt:

1. Accounts receivable financing

2. Factoring

3. Inventory financing

4. Floor planning

5. Revolving credit

6. Zero-balance accounts

7. Lines of credit

8. Credit cards

9. Compensating balances

Accounts Receivable Financing. This is an excellent form of short-term financing that assists the company in its cash flow management. It involves using part or all of accounts receivable as collateral for short-term loans. The collateral might include only specific invoices if some of the invoices are over 90 days old or if some customers’ credit is not of high quality. (If the latter is true, maybe these customers shouldn’t be given credit at all.) By refusing to lend against these invoices, the bank is protecting itself from lending against the receivables of low-credit-rated customers. At the same time, it is giving the company some sound advice regarding dealings with these customers.

With accounts receivable financing, the company retains the credit risk if its customers do not pay, and the company is responsible for collecting on its customers’ accounts. Repayment schedules for this type of financing are highly negotiable. The company should make certain that undesirable inflexibilities are not built into the repayment terms. There are critical ‘‘shades of gray’’ between financial discipline and bank-imposed restriction. Banks and other lenders will typically create a line of credit equal to between 70 and 90 percent of qualified accounts receivable.

Factoring. In this financing alternative, the company actually sells its qualified accounts receivable to the bank or an independent factoring company at a discount from the face value. The company receives immediate cash for its invoices. The invoices will direct the customers to pay the funds directly to the bank or factoring company (the factor).

This form of financing is expensive compared with alternative forms. In addition, it may lead customers to misjudge the financial position of the company and conclude that it is having financial difficulties. The factor may have the right to take the initiative and call overdue accounts directly.

Factoring can cost between 2 and 5 percent per month. This could significantly cut into margins, especially if the borrower is in a low-margin business. However, if the terms of sale are currently 2/10, n/30, factoring may be a desirable alternative. Selling on terms of 2/10, n/30 means that the customer can take a 2 percent discount off the invoice amount if the invoice is paid within 10 days of the invoice date, and in any event payments are expected within 30 days. With these terms, customers will either take the 2 percent discount or delay payment for up to 30 days. If factoring can be accomplished at 2 percent and the company can get its cash immediately, factoring is an attractive alternative.

Accounts receivable can be sold to a factor with or without recourse. If the sale is without recourse, the buyer of the accounts receivable (the factor) assumes the full credit risk. If the customer does not pay, the factor loses the money. If the sale is with recourse, the company assumes ultimate responsibility for credit losses if the customer does not pay. Selling without recourse is very expensive. Because only very high-quality receivables qualify for this form of financing, there is rarely a credit loss. So selling without recourse rarely pays. Companies can actually buy credit insurance that protects them against credit loss.

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