Short-term debt, also known as current liabilities, is a type of debt that must be paid within one year. These debts generally include operational expenses and operational activities such as accounts payable, short-term leases, and bank loans. Short-term debt can also be used to finance short-term projects, such as inventory purchases, research and development investments, and daily operations, until the project produces revenue.
An increasing amount of short-term debt can show a business’s increasing dissatisfaction with its current market performance. The investment bankers also examine the debt-to-equity ratio of a company when considering a potential issuer. This ratio considers the total amount of debt a company has relative to its equity and provides a quick snapshot of a company’s financial health.
A company might take on short-term debt if it is unable to access long-term financing options, such as raising capital through successive rounds of issuer stock offerings. Short-term debt enables a business to pay for products ordered from suppliers on credit and to fulfill contract requirements, like completing a project within a certain timeline. In the event the net income of the business is not enough to cover the monthly payments, the company turns to short-term debt.
Taking a loan may give the business access to needed resources and time, but it also brings additional risks, such as the possibility of defaulting on the principal and interest payments due as a result of not generating sufficient revenue. Furthermore, taking on too much short-term debt can put the business in a precarious situation in which it has to be diligent in managing cash flow. The debt-to-equity ratio should be monitored by the business owner and other investors to ensure that the business’s operations remain viable.
Other potential risks to manage include costs associated with taking out a loan, liquidity risks associated with not having enough cash to pay the loan, and reputational risks associated with not honoring obligations to lenders.
Proper management of short-term debt is essential for a business to remain financially stable. An important first step is to ensure that the cash flow is adequate to cover the current expenses. The business should review its operational costs and the proportion of fixed and variable costs, in order to better align spending with the company’s financial goals. The business should also take steps toward increasing its revenue and consider refinancing options to secure lower-cost financing.
Short-term debt can be beneficial to a business as it can provide funding when immediate capital requirements arise, however, businesses must be cautious when taking out loans. Taking on too much debt can put the business in jeopardy, while not enough debt can limit the business growth potential. Business owners should seek advice from financial experts to determine the right measures to manage debt and maintain a positive outlook on their operations.
