What Is Short-Term Debt Financing?

Short-term debt financing is a strategy that focuses on securing and allocating funds that can be used to manage expenses that must be settled in less than one calendar year. Debt financing of this type will often focus on managing the expenses involved with the daily operation of the company, with those expenses including the need to meet the weekly, bi-weekly, or monthly payroll, purchase materials used in the manufacturing of goods and services, and even buying and paying for office supplies. Short-term debt financing can be accomplished in several ways, including drawing on a business line of credit, factoring the accounts receivables of the business, or even obtaining a short-term business loan from a bank or other type of lender.

The goal of short-term debt financing is to cover necessary expenses that are incurred while operating the business from day to day. While a portion of this type of debt is offset by the cash flow from sales and investments made by the business, there is sometimes the need to utilize additional options to manage the debt in a timely manner. Generally, one of the goals of short-term debt financing is to keep the amount of interest and penalties accrued on those debts as low as possible, a move that ultimately means less stress on the cash flow of the business.

One common method of short-term debt financing is the use of a business line of credit with a local financial institution. This approach makes it possible to use that credit line to settle short-term expenses before they begin to accrue interest or penalties. In the best case scenarios, a company can then pay off the credit balance using cash flow from receivables to settle that balance before the next billing period starts, a move that further limits any interest accruing on the debt.

When a business line of credit is not feasible, working with a factoring company to receive an advance on the current receivables is sometimes a good move. Factoring companies assess the receivables, then issue an advance to the client that is usually between 80% and 90% of the face value of those invoices. Customers remit payments for those invoices directly to the factoring company, which tracks the receipts and credits them to business’s account. When the batch of invoices are paid in full, the factoring company provides the rest of the face value of those invoices to the business, less a small percentage for the service. This approach allows the business to use tomorrow’s receipts to manage expenses today.

A third option with short-term debt financing is to obtain a business loan from a bank or other lender. This approach normally calls for a short-term loan of less than one year, with the loan repaid in monthly installment payments over that period of time. This approach works very well for any business that experiences consistent seasonality with the sale of its goods and services. The proceeds from the loan can be placed into an interest bearing account and used to cover expenses during those slower periods. During the seasons in which higher volumes of sales result, the balance of the loan can be settled. Assuming the interest rate on the loan is lower than the interest and penalties that would be incurred by making payments late on those day-to-day expenses, this arrangement can save the business a great deal of money.