Q. Explain Short- and long-term financing mix?

In forming a fresh business there is no business history to present to the bank thus there is additional uncertainty which will need to be considered before any finance is probable to be forthcoming either of a short-term or a long-term nature.

If though there is a good relationship with the bank an overdraft might be possible for the entire financing requirement but this runs the risk of being payable immediately on demand and thus if planned cash flows didn't turn out as expected then the bank may get nervous and possibly withdraw credit facilities.

A medium-term loan would as well be possible to meet the entire financing requirement. This has the benefit of security in that it cannot be recalled unless there is a breach in the terms. Most probable it would come from a bank, the issue of debentures being entirely out of the question on the grounds of scale. Erstwhile considerations would be the term of the security required, loan, fixed or variable interest rates, other conditions (example covenants, accounts and reviews).

Other forms of finance comprise leasing which can be regarded as a quasi loan if entering into a long-term contract although other considerations may apply such as variability of rental terms residual value of asset, transfer of risk, cancellation rights, amount of rentals, period of agreement.

A further choice would be for Mr Geep to put in more ownership capital perhaps secured on the equity in his house. A mixture of these a variety of forms of finance would be most likely.

The accurate mix will depend upon a number of factors (although some of these may as well influence the total amount of finance needed)

- The ability as well as willingness of Mr Geep to supply funds initially and additionally if plans do not turn out as expected.

- A loan would require a few security. The company has only some assets to use as security as there does not appear to be any property and the machinery has a low net realisable value and there is little inventory which is normally poor security anyway. An overdraft may as well require security but may place increased emphasis on the cash generating potential of the business to make appropriate repayments. Eventually though this is an unlimited business and Mr Geep's personal assets and particularly the equity in his house will act as security.

- Other costs are essential including the drawings of the owner Mr Geep and interest charges. These will decrease the ability of the business to repay any loan and thus extend the period of repayments in excess of the above estimate of 35 months.

- There may be more restricted covenants in a loan agreement than an overdraft as an overdraft is repayable on demand and thus the bank needs less protection from other clauses in the contact. There are though likely to be restrictive covenants in overdraft agreements.

- Overdraft interest is merely payable on the balance outstanding thus if major inflows occur this will reduce interest costs.

- The difference among short- and long-term interest rates may influence the relative charges on an overdraft or a medium-term loan.

- The purpose of the finance is as well likely to affect the form of finance. For instance if funds are required to finance fixed assets then it might be appropriate to use longterm finance to match the long-term usage of the asset.