There are usually two common reasons why a company gets a business loan. The first is the result of actions undertaken to raise funding to grow the business, while the other is meeting the obligations arising from normal business operations.
However, many business owners are taking in numerous amounts of short-term debt for the wrong reason.
Financing debt for a real business is normally considered to be long-term, in that it is has a maturity date longer than 12 months and is usually listed after the current liabilities portion in the total liabilities section of the balance sheet. This type of financing will be through banks and financial institutions, which is useful in the growth of a good business, be it in expansion or acquisition.
Short-Term Debts are useful for activities that are required to run a business, such as accounts payable, and are expected to be resolved within 12 months. As it may be due to some delays from the collection of funds from your customer, or a sudden influx of purchases of goods which in turn will be able to bring in revenue in just a few months.
The value of the short-term debt is very important when determining a company's performance. Simply put, the higher the debt to equity ratio, the greater the concern about company liquidity. If the debt is larger than the company's cash and cash equivalents, this suggests that the company may be in poor financial health and does not have enough cash to pay off its impending obligations.
A company needs to be clear that taking a short-term loan is never for expansion, pay for rent, for payroll purposes, or to repay another loan. Likewise, if the company has a cash balance that is insufficient to run the business for the next 6 months, taking a short-term debt will make it a lot worse. It is only to bridge the gap while waiting for funds or revenue to be received in the next 90 days.
If the company is taking a short-term debt totally for the wrong reasons, it may end up debt stacking. They may have to relook into their business model on what is going wrong, as it may be better off to let another party acquire the business.