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Long-Term Finance

Explain to Mr.Patrick Lim the differences between long-term or short-term financing.  Advise Mr.Patrick Lim to source for long-term of short-term financing? give reason for your advise?  Brief Mr.Patrick Lim on the various types of financing suitable for the purchase of this lastest technological equipment.

The issue that has been presented in the question is the case study is that the public listed company has been awarded a contract to resurface the Pan Island Expressway, for which an estimated amount of $1,500,000 is needed for purchasing the latest technological equipment to increase the speed and efficiency of the job. Thus, the managing director of the organization has been asked to look for the cheapest source of finance.

Therefore, this particular study aims to look into the various sources of short term and long-term financing and the type of financing that is suitable for purchase of the latest technological equipment. It further looks into the types of financing that a company should use.

Finance or funds that are obtained for a time- period of more than one year are known as long-term finance. Long-term finance essentially consists of the financial obligations, loans, or leases that will be due for payment after a time-period of twelve months. Long-term finances also apply to governments as the nations often have long-term debts. Long-term financing essentially is included in the balance sheet of a company under the head of non-current liabilities. This is because a long-term debt is a liability for a company that will be due by a minimum period of twelve months. However, any part of the long-term finance that is payable within a time of twelve months will be included under the head of current liabilities. The most common type of long-term debt is bonds (Barton and Wiseman 2014).

Short-term finance refers to the finance that is needed by many businesses as an additional fund for covering the expenses that are incurred by the firms in the due course of business. Short-term loans are the only resort for businesses dealing with seasonal revenue fluctuations. The short-term finance that has been borrowed by business will be mandatorily due within a period of twelve months. This is because once the fund that has been borrowed becomes due for more than a period of twelve months, it becomes long-term finance. The most important difference between a short-term and a long-term loan is that the former is included under the head of non-current liabilities in the balance sheet while the latter is included under the head of current liabilities in the balance sheet of the company (Gitman, Juchau, and Flanagan, 2015).

Short-Term Finance

The type of finance that suitable for the purchase of technological equipment is the long-term finance. A number of factors have been considered for arriving at the stated conclusion that the long-term financing would be the cheapest and the most suitable method of financing for purchasing the technological equipment. Firstly, the amount that has to be borrowed for the purchase of the equipment is a one-time expenditure. This means that the firm does not need to borrow funds on a recurring basis. However, it should be noted here that the company being a construction will be in the requirement of the technological equipment in the following years to come. Moreover, the PSD Company needs to purchase the latest technological equipment for the resurface of the expressway, which is a long-term project. Thus, after the successful completion of the project the company will be able to ensure the optimum utilization of the asset by using the technological equipment in the other projects that it undertakes. Now, in such a case if long-term financing is opted for then, the firm will be able to incur the loan for such an amount at the lowest possible installments. This is majorly because the loan that is incurred is a long-term loan hence the initial amount that is required to borrow such a loan would be the cheapest. Hence, the particular recommendation in regards to the cheapest source of finance for the purchase of technological equipment is a long-term loan from a financial institution or Mr. Patrick Lim can also opt for leasing the particular machinery from a leasing company.

The various types of long-term financing that is suitable for the purchase of latest technological equipments can be listed down as follows:

  • Capital Market – capital market refers to the mechanism that has been utilized by the companies for raising long-term debts or funds. Therefore, a capital market essentially facilitates the long-term borrowings from the financial institutions and banks, borrowings from the foreign markets and the technique of raising capital through the various financial instruments like the bonds, shares and debentures. The capital market can be further divided into two types of markets that are primary market and secondary market. The primary market constitutes of the securities that have been freshly issued thus, is known as the new issue market. The secondary market on the other hand deals with process of purchase and selling of the already existing securities thus, is known as the stock market. The PSD Company can obtain the required debt from the new issue market by issuing its shares.
  • Special Financial Institutions - The special financial institutions refer to the institutions that have been established for facilitating the providence of long-term debts to the business enterprises. The special financial institutions also provide support funds to the business enterprises that are in the nature of start-up ventures. Some of the important functions of the special financial institutions include granting loans for industrial establishments, provide finance for developing a backward economy, offer services for training and developing the entrepreneurs of the future and providing technical and professional services for the execution and evaluation of the upcoming business projects.
  • Non-banking financial companies – the non-banking financial companies are of similar nature to the banking companies. They carry out the dual role of accepting deposits and forwarding loans. However, they are known as the non-banking financial institutions as they do not carry out the same operations same as the banks. These financial companies raise the necessary funds from the public at high, attractive rates of interests and forward these loans to the retailers and the wholesale traders, small-scale business houses and self-employed persons. The natures of loans that are granted by these organizations are generally unsecured loans. Moreover, the other facilities provided by these non-banking financial companies are hosing finance, hire purchase business, lease financing etc.
  • Mutual funds – mutual funds refer to the funds that have been established for the purpose of raising funds through securities. It is a specialized institution of investment that acts as an investment intermediary that result in the collection of the savings from a huge number of investors. The institution turns these investments into in a well-diversified portfolio that consists of sound investments. The investment institution initiating the investment in the mutual funds also facilitate the protection of the funds by minimizing the associated risks and ensuring good returns to the investors.
  • Leasing companies – The leasing companies are essentially the companies that buy the required plant and machinery from the manufacturers and forward the lease to the companies that are in the requirement of the equipments at a cheaper price. The leasing agreement is usually facilitated between the lessor that is the company that leases the particular asset and the lessee, that is the company that hires the particular asset. These leasing companies also facilitate the leasing the fixed assets from the companies that are in the dire need of finance. It should be noted here that the ownership of the funds remain with the leasing companies during this tenure.
  • Foreign sources – The foreign sources play a crucial role in meeting up to the long-term financial needs of a company. This means that the foreign sources lead to the generation of the different types of funds like the deposits from the NRIs, external borrowings and investments that are foreign in nature.

The types of financing the company should use is long term financing. This is because the company has engaged itself in a long-term project that in all probabilities, will take more than twelve months. Moreover, even if the selected project takes less than twelve months (short-term project), the company being a construction company, will be able to utilize the technological equipment in the upcoming projects that are to be undertaken. Therefore, as discussed above, long-term financing refers to that type of financing that will be due in more than twelve months. Furthermore, the company may also opt for leasing the technological equipment from one of the leasing companies. This will not only help the company to fend off the depreciation charges of the equipment but also enable it to opt for a much more modified equipment, required in the future. This means that the capital that has been invested by the company in leasing the equipment will not be blocked. (Waemustafa and Sukri 2016).

Conclusion

Therefore, as it can be concluded from the preceding paragraphs, the two major methods of financing are long-term and short-term debts. The situation that has been described in the case study requires the long-term financing.  This means that the company should obtain the required loan from the specialized financial institutions or the leasing companies. However, the availability of the exact time-period of the completion of the construction project would have helped in the achievement of a much more viable solution. To be more precise, had the project life been less than one year, the technique of financing adopted would change to short-term debts

References

Barton, D. and Wiseman, M., 2014. Focusing capital on the long term. Harvard Business Review, 92(1/2), pp.44-51.

Bebchuk, L.A., Brav, A. and Jiang, W., 2015. The long-term effects of hedge fund activism (No. w21227). National Bureau of Economic Research.

Chernykh, L. and Theodossiou, A.K., 2015. Determinants of bank long-term lending behavior: Evidence from Russia.

Gitman, L.J., Juchau, R. and Flanagan, J., 2015. Principles of managerial finance. Pearson Higher Education AU.

Hanson, S. G., & Stein, J. C. (2015). Monetary policy and long-term real rates. Journal of Financial Economics, 115(3), 429-448.

Martin, A., Skeie, D. and Von Thadden, E.L., 2014. The fragility of short-term secured funding markets. Journal of Economic Theory, 149, pp.15-42.

Minsky, H.P., 2015. Can" it" happen again?: essays on instability and finance. Routledge.

Ortiz?de?Mandojana, N. and Bansal, P., 2016. The long?term benefits of organizational resilience through sustainable business practices. Strategic Management Journal, 37(8), pp.1615-1631.

Rapach, D.E., Ringgenberg, M.C. and Zhou, G., 2016. Short interest and aggregate stock returns. Journal of Financial Economics, 121(1), pp.46-65.

Waemustafa, W. and Sukri, S., 2016. Systematic and unsystematic risk determinants of liquidity risk between Islamic and conventional banks.

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[Accessed 12 June 2024].

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