Question

In: Economics

Businesses can borrow from banks or by issuing short-term or long-term debt on the open market....

Businesses can borrow from banks or by issuing short-term or long-term debt on the open market. Why do they prefer to finance themselves with retained earnings rather than issuing debt? If they are issuing debt, when and why would a corporation prefer to borrow by issuing short term vs long term?

Solutions

Expert Solution

Answer : Retianed earning is a part of profit which are left over to meet the future requirement of the business. It means utilising your profit for the expansion of the business. The business has been used retianed earning as source of finance because :

  • Using retianed earning have no cost to the company.
  • If we used the debts than there is issue related cost but in case of retianed earning it is zero.
  • Using retianed earning cannot affect the ownership of the business. Existing shareholders are only the owners.
  • Less legal formalities in retianed earnings as compare to issuing debt . It is just required resolution passed in annual general meeting.
  • Cheaper source of finance as there is no cost incurred.
  • Retianed earnings strengthen the financial position of the company and appericate the value of the share where as debt means increasing in loan amount payable.

-----------------------------------------------------------------------------------------------------------------------------------------------

When the company need finance for paying the expenses or expansion of the business than they can used different source of finance. One source of finance is issuing debentures. There are two types of debt such as :

  • Short term debt is to be paid off within 12 months.
  • Long term debt is to be paid after 12 months or it may to 2-5 years.

It depend upon the need of the business which long term or short term fund has been raised from the market :

  • Payment of payroll
  • Meeting extra production cost
  • Unexpected cash flow issues
  • Purchasing raw material in bulk.
  • Property Taxes

Long term debt has been raised by the business such as :

  • Expansion of the business
  • Lease and mortgage
  • Loan for purchasing costly equipment.

Example of Long term debt :

  • Bonds
  • Lease obligation
  • Contingent Liabilities

CRUX : It is directly depend upon business requirement which funds should be raised.

Rahul Sunny answered 1 year ago
Next > < Previous

Related Solutions

Most companies borrow money for long term projects and in addition to this long term debt...
Most companies borrow money for long term projects and in addition to this long term debt they also have other long term commitments (such as a lease). What types of long term commitments might a company have and how do we gauge their ability to pay these commitments in the future?
Companies can use three basic type of financing in their business – short-term debt, long-term debt...
Companies can use three basic type of financing in their business – short-term debt, long-term debt and equity. Briefly discuss the nature of each and give examples. What are the possible consequences if a company uses short-term debt to fund long-term projects, and uses long-term debt or equity to pay current liabilities?
outline the advantages of using short term debt as opposed to long term debt in the...
outline the advantages of using short term debt as opposed to long term debt in the financing of working capital. support with references
In the market for reserves, assume that banks just borrow from other banks, but not from...
In the market for reserves, assume that banks just borrow from other banks, but not from the federal reserve system.What happens to the federal funds rate when discount rates are lowered? Is the Federal Reserve Bank able to control the federal funds rate here? Draw the graphand explain.
In the market for reserves, assume that banks just borrow from other banks, but not from...
In the market for reserves, assume that banks just borrow from other banks, but not from the federal reserve system. What happens to the federal funds rate when discount rates are lowered? Is the Federal Reserve Bank able to control the federal funds rate here? Draw the graph and explain in simple terms.
Short-term or long term why is it important to lower the national debt?
Short-term or long term why is it important to lower the national debt?
A high and rising level of long-term debt relative to short-term debt might signify that:
A high and rising level of long-term debt relative to short-term debt might signify that: (a) inflation expectations are worsening; (b) monetary policy is too tight; (c) borrowers have confidence in the outlook for inflation and real economic growth; (d) major debt restructuring is imminent.  
What are the short-term and long-term effects on the environment that can arise from the construction...
What are the short-term and long-term effects on the environment that can arise from the construction of dams?
What is the difference between short-term debt and long-term debt? Describe in detail how debt relates...
What is the difference between short-term debt and long-term debt? Describe in detail how debt relates to financial management
41. A high and rising level of long-term debt relative to short-term debt might signify that:...
41. A high and rising level of long-term debt relative to short-term debt might signify that: (a) inflation expectations are worsening; (b) monetary policy is too tight; (c) borrowers have confidence in the outlook for inflation and real economic growth; (d) major debt restructuring is imminent. 42. Normally, falling tax rates and rising government spending can be expected to: (a) dampen investment spending; (b) cause long-term interest rates to fall; (c) win legislative approval from the Federal Reserve; (d) create...
ADVERTISEMENT
Subjects
ADVERTISEMENT
Latest Questions
ADVERTISEMENT