All kinds of businesses, regardless of their size and industry, need financing at some point in their growth journey. Long-term financing is usually needed for acquiring fixed assets like machinery, plant, and other long term assets.
The primary reasons businesses need long-term financing are:
To launch a business
Money is the foremost requirement for starting any business. You need finances to purchase resources, assets, and employees. You also need finances to cover the operational costs of a business. Finances for business launches are required before the business starts generating enough to pay for these costs.
To expand a business
There comes a time when every business need to take the next step and expand. And to grow a business in size, you need finances to bring in new technology and keep up with competitors. Buying new technology is relatively expensive and businesses need to opt for long-term financing. This is because the cost to buy new tech will outweigh the revenue generated or saved by the business for a considerable amount of time.
In our last segment, we have already discussed what long-term financing is and the sources of long-term financing. In this segment, we will learn about how businesses can leverage long-term financing for their business growth and development.
Also Read: Best Way To Know The Latest Business Trends
Is Long-Term Financing Right for Businesses?
Long-term financing offers businesses a large amount of capital for long-term use. This is the type of financing most large, successful businesses that have a long-documented financial history, a purpose for the proposed working capital, and plenty of collateral go for. Often large, traditional banks provide such loans.
The pros of long-term financing include its capacity for high-dollar capital, ideal for businesses that need large amounts of cash for massive marketing campaigns, extensive product development, international expansion, and other huge costs of operating a large business. A longer-term repayment allows businesses to keep payments manageable on larger loans.
Let’s learn in detail about the advantages of long-term financing:
- Stability: Offers businesses the stability they need to grow and expand. With long-term financing, businesses can become more stable in debt management than with short-term loans. Further, it also lets borrowers have more security when making budgets for expenses and costs as the time period of long-term financing is fairly long. Also, they don’t need to worry about repaying back over a shorter period.
- Boost Overall Company Productivity: As in the case of short-term loans, these are used as a quick source of cash to manage short-term liquidity problems. However, long-term financing is mostly used for capital investments, such as machinery, real estate, furniture, leases, and vehicles. Such capital investments provide real benefits to an organization by either expanding its operating capacity or increasing its productivity. For instance, a successful realtor company can use a mortgage to start its new project and increase its profit potential. This is a classic example of long-term debt financing.
- Flexibility: Long-term financing is flexible and can be leveraged as per the business’s needs. There is a range of long-term debt financing options available to businesses, such as leases, mortgages, reverse mortgages, and loan refinancing. All these options can be fine-tuned to meet the business’s needs. Hence, borrowers have more flexibility and better control over overspending. A lease, for example, is a special type of long-term financing that lets the lessor benefit from the asset used in exchange for rental payments without having to purchase the asset.
Important Points to Note
- The company’s credit rating plays a major role in acquiring long-term finances. Hence, businesses should work on improving their company’s credit rating, which might help them raise long-term funds when needed, at a much cheaper rate.
- The management of a company needs to be assured about creating a mix of sources of long-term and short-term financing. This is because more long-term funds may not benefit the company and can affect its ALM position significantly.
Limitations of Long-Term Financing
While long-term financing enables businesses to obtain high-dollar loans for various reasons, they are out of reach for many types of businesses. Moreover, some may find them unwanted because of the extended repayment obligation. Here are some of the limitations of long-term financing:
- The regulators have strict regulations when it comes to the repayment of principal and interest.
- Businesses may bankrupt because of stringent provisions under the IBC Code for non-repayment of debt obligations.
- Financial covenants monitoring in the term sheet is a challenging task.
- High gearing on the business may affect the company’s valuations and future fundraising.
For more information or study material on management-related topics, keep visiting Easy Management Notes.