Introduction to Finance

FIGURE 16.7
 Patterns of 
Short-Term and Long-Term 
Financing Needs Over Time 
for a Growing Firm

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498
C H A PT E R 1 6 Short-Term Business Financing
the time and cost of fl oating a bond or stock issue or negotiating a long-term loan or private 
placement, long-term securities are usually issued only in large quantities, as seen in Panel B 
of Figure 16.7.
Cyclical Variations 
The need for current funds increases when the business cycle or 
the sales cycle of an industry experiences an upswing. Since the cycle is not regular in timing 
or degree, it is hard to predict exactly how much, or for how long, added funds will be needed. 
The need should be estimated for a year ahead in the budget and checked quarterly. When 
the sales volume of business decreases, the need for funds to fi nance accounts receivable and 
inventory will decrease as well. The need for fi nancing may increase temporarily during the 
downturn. This will occur if the cash conversion cycle lengthens, as receivables are collected 
more slowly and inventories move more slowly and drop in value.
If cyclical needs for funds are met by current borrowing, the loan may not be self-liquid-
ating in a year. There are hazards in fi nancing these needs on a short-term basis. The lending 
institution may demand payment of all or part of the loan as business turns down. Funds may 
be needed more than ever at this stage of the cycle, and the need may last until receivables 
can be collected and inventory can be reduced. Firms in cyclical industries should use a more 
conservative approach that makes use of long-term fi nancing. Major U.S. automobile fi rms, in 
their highly cyclical business, prepare for the next recession by building cash reserves. Ford 
Motor Company, for example, went through $10 billion in cash during the 1990–1991 reces-
sion and $8.5 billion during 1999–2001. 
CRISIS
At the beginning of 2006, before the 2007–2009 Great Recession and credit crisis 
hit, Ford and its car fi nancing subsidiary had over $39 billion in cash and short-term market-
able securities as a cushion. General Motors had over $50 billion and DaimlerChrysler had 
$7.1 billion in cash and marketable securities. For these latter two fi rms, the cash was insuffi
-
cient, as GM fi led for bankruptcy and received a U.S. government rescue fi nancing package. 
DaimlerChrysler was sold by its German parent fi rm, received government bailout funds, and 
is now known as FCA US LLC, better known as Fiat Chrysler.
Other Influences in Short-Term Financing
Using short-term borrowing rather than other forms of fi nancing has other advantages. Short-
term borrowing off ers more fl exibility than long-term fi nancing since a business can borrow 
only those sums needed and can pay them off if the need for fi nancing diminishes. Long-term 
fi nancing cannot be retired easily, and it may include a prepayment penalty, as is the case with 
the call premium for callable bonds. If an enterprise fi nances its growing current asset require-
ments entirely through long-term fi nancing during a period of general business expansion, it 
may be burdened with excess funds and fi nancing costs during a subsequent period of general 
business contraction. Using short-term fi nancing along with long-term fi nancing creates a 
fi nancial fl exibility that is not possible with long-term fi nancing alone.
Short-term fi nancing has advantages that result from continuing relationships with a bank 
or other fi nancial institution. The fi rm that depends almost entirely on long-term fi nancing for 
its needs will not enjoy the close relationship with its bank that it might otherwise. A record of 
frequent borrowing and prompt repayment to a bank is important in sound fi nancial manage-
ment. A bank will make every eff ort to accommodate regular business customers who do this. 
The enterprise that has not established this working relationship with its bank will scarcely 
be in a position to seek special loans when it has emergency needs. The credit experience of 
a business with short-term fi nancing may be the only basis with which its potential long-term 
lenders will be able to judge it. Hence, the business that intends to seek long-term loans may 
wish to establish a good credit reputation based on its short-term fi nancing.
Off setting these advantages of short-term fi nancing is the need for frequent renewals. 
Even though short-term credit is usually easy to obtain, time and eff ort must be spent at fre-
quent intervals because of the short duration of these loans, and when sales revenues decline, 
a great deal of negotiation may be required to receive needed credit.
Frequent maturities create an added risk. The bank or fi nance company can call the loan 
whenever it is due, and the bank, then, may not want to roll over the loan. Borrowing costs 
may rise if short-term interest rates increase. A company in a temporary slump due to the 

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16.3 Providers of Short-Term Financing
499
business cycle or some internal problem could work out its problems in time with adequate 
fi nancing. If the company had acquired funds on a long-term basis, it might have a better 
chance of resolving its problems. On the other hand, if it relies heavily on short-term fi nan-
cing, its loans may be reduced or not renewed, which may make it impossible to recover and 
might lead to liquidation.
Now that we have an understanding of short-term versus long-term fi nancing strategies 
and factors that aff ect the relative use of short-term fi nancing, we turn our attention toward 
various sources of short-term fi nancing. Short-term fi nancing sources include bank loans, 
trade credit or accounts payable, and commercial paper, among others. Financial managers 
should recall the fi ve C’s discussed in the Chapter 15 section on accounts receivable manage-
ment; the ability to obtain short-term fi nancing is made easier for fi rms with acknowledged 
character (ethics), the capacity to pay bills, a strong capital base, collateral to act as security 
for loans, and with favorable conditions in the economy and the fi rm’s industry.