Classification of Debt Finance
Short term finance
This ranges from 1 month up to 4 years and is given to customers known to the bank or to lenders. The agreement of this loan will mention both the repayments of principal and interest, and for interest it must identify whether it is simple or compound interest. For principal, it has to be paid over some time. This finance is usually secured and the terms of the loan will be restrictive e.g. to be invested in an area acceptable to the bank or lender. Usually, this finance should be used to solve short-term liquidity problems.
Medium-term finance
This finance will be in the business for a period ranging between 4-7 years. This term is relative and will depend upon the nature of the business. This type of loan is used for investment purposes and is usually secured but the security should not be sensitive to the company’s operations. The finance obtained must be invested while respecting the matching approach to financing i.e. the term and payback period must be matched. This type of finance is the most popular of all debt financing because most of the busineses will need it both in their growing stages and also in their mature stages of development.
Long-term finance
This is a rare finance and is only raised by financially strong companies. It will be in the business for a period of 7 years and above. This finance is used to purchase fixed assets in particular during the early stages of a company’s development. It is always secured with along term fixed asset, usually land or buildings. Its investment, however, must obey the matching approach. In all, the companies needing such finance do not have to be known to the lenders.
