Short-Term Debt: Definition, Types & Examples
There are a number of different types of debt.
It’s common for people to think that debt is always a bad thing. But debt can actually be beneficial in a number of different ways. The most common types of debt are long-term debt, and short-term debt.
In this article, we’re going to take a look at short-term debt.
We’ll discuss exactly what it is, the different types of short-term debt, and how you can pay off your debt effectively so as to not incur any further issues.
Table of Contents
- Short-term debt is any total debt that must get paid by a company, either within the next 12 months or within the current fiscal year
- Some of the most common types of short-term debt include accounts payable, lease payments, wages, income taxes payable, and short-term bank loans
- Short-term debts are also called current liabilities and these can be found on the balance sheet of a company
- The quick ratio is the most common measure of short-term liquidity, which helps determine the credit rating of a company
What Is Short-Term Debt?
Short-term debt is any debt obligations that a company needs to pay back. It’s either paid within the current fiscal year of a business or within the next 12-month period. It can also be common to refer to short-term debts as current liabilities.
These are observed on a company’s balance sheet under the current liabilities section. It’s also worth noting that short-term debt can relate to either business debt obligations or personal financial obligations.
It works differently compared to long-term debt, which is any debt obligations that are due more than 12 months in the future.
Types of Short-Term Debt
Types of Short-Term Debt
When it comes to the debt obligations of a company, they’re usually divided into two distinct categories: operating debt and financing debt.
Operating debt gets incurred while the company conducts its ordinary business operations. This includes things like accounts payable. This is the liabilities account a business has and it tracks outstanding payments to the likes of vendors or stakeholders.
For example, if a company purchases a new piece of machinery on short-term credit, the amount gets categorized in accounts payable.
Financing debt, on the other hand, refers to the debt obligations that occur when a company borrows money. A company usually does this to help fund capital expenditures, for example. In this case, the company might issue bonds or take out a large bank loan to build a new warehouse.
Short-term bank loans are found on the balance sheet of a company when they need working capital. It can also get known as a bank plug since it’s often used to help fill a gap between financing options. Short-term bank loans are also some of the most common types of short-term debt.
Another type of short-term debt is commercial paper, which is an unsecured debt instrument that gets issued by a corporation. This is usually done when they need to finance things like inventories and accounts receivable. Or when there’s a need to meet other short-term liabilities, such as payroll.
In the case of commercial paper, maturities don’t usually last longer than 270 days and they get issued at a discount to reflect fluctuating market interest rates. It can be a very useful short-term debt since a company doesn’t need to register its liabilities with the Securities and Exchange Commission (SEC).
Here are some other types of short-term debt that might depend on certain circumstances:
- Salaries and wages — normally salaries and wages are accruing in payroll liability accounts until it’s time to pay, similar to Accounts Payable. Payroll liabilities are cleared by payroll payments on a weekly, bi-weekly or monthly basis.
- Lease payments — some leases are expected to get paid off within one year, otherwise, most leases are typically long-term debt
- Taxes — if quarterly taxes still need to get paid by a company, they could get considered a short-term liability
Examples of Short-Term Debt
There can be many forms of short-term debt to know and understand. That said, here are some of the most common examples to be aware of:
- Short-term loans — If a company needs to take out a short-term loan from a lending institution or a bank, it can help them fix a cash flow problem. Or, if a company finds it challenging to collect accounts receivable, a short-term loan can help cover its accounts payable.
- Accounts payable — This includes any money that a company still owes through an ordinary credit purchase. These purchases are made to suppliers, for example, to help stock products. Accounts payable also include things like office rent, utility bills, and other monthly bills.
- Lease payments — Leasing instead of purchasing can be common for companies. If any of the lease payments are due within the next 12 months, they get considered short-term debt for the company.
- Commercial paper — Issuing commercial paper is an alternative for a company instead of taking out a bank loan. In this case, unsecured promissory notes are typically due within 9 months, making it a short-term debt.
- Stock dividends — If shareholders have been notified that they would be paid stock dividends but haven’t yet, those dividends then become short-term debt for the company.
Taxes due — If taxes are due within the current year they become short-term debt. And these include any local, state, federal, or other types of taxes due to be paid.
How to Pay Off Short-Term Debt
There can be a few ways to pay off short-term debt, but before you get started it’s always important to know your borrowing limit to better manage your debt load. In the case of a company’s short-term debt, they will likely have a payoff strategy in place that would come through generating additional revenue.
In the case of personal short-term debt obligations, earning extra income, reworking your budget, and categorizing debts can all help you pay off short-term debt.
What Are the Pros and Cons of Short-Term Debt?
One of the best ways to gain quick access to new capital is to take on short-term debt. This can help fund things like equipment, labor, and supplies. There are a few things worth highlighting when it comes to the pros and cons of short-term debt. Let’s take a closer look.
Pros of Short Term Debt
- There is often relaxed eligibility requirements from short-term lenders
- You can get approved for short-term debt in as little as a few days or less
- Payment plans allow you to pay off debt fast, with plans no longer than 18-months
Cons of Short-Term Debt
- You’re offered higher interest rates compared to other types of debt
- There becomes a high-cycle risk if you can’t make payments on time
- You might end up spending more compared to a lower-cost term loan from somewhere else
The short-term debt relates to any portion of total debts that a company needs to pay off. And these must happen within the next 12 months or within the individual company’s current fiscal year.
With long-term debts, these are debts that are due when the repayment period extends past 12 months into the future. Some of the most common examples of short-term debt include short-term loans, wages due to employees, lease payments, current taxes due, and salaries.
Frequently Asked Questions
Not necessarily. Short-term debt can be a good strategy to get extra financing when it’s required. The biggest downfall to short-term debt can be the high-interest rate compared to other debt.
There are a few things taken into consideration. The amount is calculated based on business revenue, credit score, business history, and experience. How the loan is used is also a consideration.
Similar to any other type of loan, having short-term debt will affect your credit score. If you take too long to pay it off or miss payments, it will have a negative effect. However, if you make payments on time and pay them off in full it will have a positive effect on your credit score.
Usually, a long-term loan is considered to be more favorable since you can get a lower interest rate, a larger loan amount, and have more time to pay it off. But, it depends on what the loan is needed for to determine whether a long-term or short-term loan is more beneficial.
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