Long-term financing means borrowing for a period longer than year. This general classification includes intermediate debt, which is borrowing for periods 1-10 years. Longer-term borrowing is often associated with:
- need for fixed assets such as a property (according to assets funding strategy,
- need for plant and equipment,
- financing the permanent part of the working capital,
- enhancing the cash flow in the firm,
- constructing or building new construction projects,
- investing in Research and Development operations,
- developing a new product,
- expanding business operations,
- designing marketing strategies,
- increasing facilities.
Longer-term notes can be issued for periods of several years, and the sources are more varied. Long-term funds should be used to cover such a short-term financing needs to avoid the crises, which could occur if capital is not available to meet a recurring short-term requirement (John B. Vinturella, Suzanne M. Erickson 2013, p. 51). Long-term financing is used in separate ways by different types of business entities. The business entities that are not corporations are only supposed to use long term financing for the purpose of debt. However, the corporations can use long-term financing for both debt and equity purposes. Long-term financing in the firms enables them to undertake large investments that might be critical for their growth. The benefits of long-term financing can accrue not only to borrowers but also to providers of funds and financial intermediaries (banks and institutional investors). Lenders might be willing to engage in long-term financial contracts because returns are higher than short-term contracts and because the maturity of these contracts might match their long-term saving needs. For the economy as whole, long-term financing might contribute to higher growth and lower macroeconomic volatility. In addition, long-term financing is critical for infrastructure projects, which by nature take many years to complete the require lumpy investments (Maria Soledad Martinez Peria, Sergio L. Schmukler 2017, p. 2).
Sources of Long-Term Financing
- Shares: These are issued to the general public. The holders of shares, otherwise called as shareholders, are the owners of the business. There are two types of shares:
- equity shares- equity shareholders are entitled to residual income of the company, but they enjoy the right to control the affairs of the business and all the shareholders collectively are the owners of the company.
- preference shares- these are instruments that have debt (fixed dividends) and equity (capital appreciation) characteristics. Preference shareholders have a higher claim on assets (repayment of capital if company is wound up) and earnings (dividends) than ordinary shareholders. Preference shareholders are paid fixed-rate dividends before dividends are paid to ordinary shareholders.
- Debentures: the holders of debentures are the creditors of the company.
- Retained Earnings: the company may not distribute the whole of its profits among its shareholders. It may retain a part of the profits and utilize it as capital.
- Loan from Financial Institutions: there are many specialized financial institutions established by the state and central governments and which give long term loans at reasonable rates of interest.
- Public Deposits: general public is able to deposit their savings with a popular and well-established company which can pay interest periodically and pay-back the deposit when due.
- Credits from commercial banks. This source of financing in long-term includes mortgages.
- Vinturella John B., Erickson Suzanne M. (2013), Raising Entrepreneurial Capital Second Edition, Elsevier Inc, page 51
- Soledad Martinez Peria Maria, Schmukler Sergio L. (2017), [Understanding the Use of Long-term Finance in Developing Economies], International Monetary Fund, page 1-10
- Sinha Sidharth (2014 ), Long Term Financing of Infrastructure W.P. No. 2014-03-23, Indian Institiute of Management Ahmedabad Research and Publications, page 1-15
- Vermoesen Veronique, Deloof Marc, Laveren Eddy (2013), Long-term debt maturity and financing constraints of SMEs during the Global Financial Crisis, Small Bus Econ, No: 41, page 433–448
- Kozlowski Julian (2017), Long-Term Finance and Investment with Frictional Asset Markets, New York University, No: November 8, 2017 page 1-20
Author: Beata Franczyk