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Never use short term borrowing to cover long term debt.

This insight is one that is so important to the continued health of a growing company that it cannot be overstated.  First, let’s be sure we know what is short in term and what is long in term.  Long term debt is taken on for the acquisition of fixed assets such as equipment, cars, facilities and acquisitions of companies or their assets.   Short term debt is often composed of accounts payable to the trade or employees for expenses, payroll liabilities, accrued but unpaid vacations, customer deposits, and the portions of any loans due to be repaid within one year.

Asset-based financing is common for companies with accounts receivable and / or inventories.  There are numerous lenders engaged in this practice, including most business banks.  Typically, companies may arrange to borrow between 70% and 80% of those non-government receivables that have not aged past 60 days from invoice, up to a maximum amount, or “credit line”.   Other companies have both the creditworthiness and relative size to be able to borrow from private and banking sources without collateral, with unsecured loans.  Many of these lines of credit require that the borrower “clean up the line” for one month out of every year, that is to be out of debt with the lender for that period to prove to the lender that the need for the cash is not permanent, used like a long term loan.

[Email readers continue here…] Numerous companies have gotten into trouble by using the easy availability of these short term lines of credit, meant for rising and falling working capital needs, to make payments upon long term obligations such as asset loan payments when due.  And worse, some even purchase assets such as equipment with money from short term loans.  Matching the term of a loan with the life of the asset is an important business principle.  Receivables are assets for only 60 days for the purpose of these lines of credit, and the available line can be reduced automatically as receivables reduce with payments by customers or aging beyond 60 days.  We all expect new receivables to be added to replace these, but a cyclic business; a disruption in the general economy; a reduction in the company’s revenues would each contribute to a reduction in the amount available for such borrowing.  To avoid the coffin corner of an over-borrowed asset-based line with no cash for working capital, remember that short term borrowings such as these should never be used to pay any long term obligations or to purchase fixed assets.

  • Thank you so much for sharing this post it is very helpful for us.

  • Another thing I’ve really noticed is for many people, less-than-perfect credit is the reaction of circumstances further than their control. Such as they may be really saddled through an illness so that they have substantial bills going to collections. It may be due to a occupation loss or even the inability to go to work. Sometimes divorce can send the finances in a downward direction. Thank you for sharing your thinking on this weblog.

  • Payday loans can be a great resource to have in the event that you need a small amount of cash quickly. When taking out one of these types of loans, however, it is important to remember to do your research and find a reputable lender, and to never borrow more than you need or are able to pay back in the agreed upon amount to time, because you don’t want to have to pay more in interest and fees than you have to.

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