Short Term Loans: A Key Current Liability
Short-term loans are a common type of current liability found on a business’s balance sheet. These financial tools provide fast access to capital for covering immediate operational needs but must be repaid within a year. While they can be highly beneficial for cash flow management and emergency expenses, short-term loans require careful oversight and planning.
It can be difficult for a start-up business to have access to capital to get started. For example, Jim wanted to open an ice cream shop that only sold butter pecan and rum raisin ice cream. Not chocolate or strawberry. No cookie dough or cookies and cream. Just butter pecan and rum raisin. Jim’s grandmother loved the idea and loaned Jim the money to start his niche ice cream shop, on the terms that Jim would pay back the money with interest within the next 12 months. This is considered a short-term loan.
What Are Short-Term Loans?
A short-term loan is a financing arrangement where a business borrows money and agrees to repay it, along with interest, in a short period; typically within 12 months. These loans are often used to:
Cover seasonal or temporary cash shortages
Purchase inventory or supplies
Handle unexpected expenses
Fund small-scale projects.
Benefits of Short-Term Loans
Quick Access to Capital
Grandma had the money in her purse to go to the casino. She might as well help out Jim instead.
Flexibility
Grandma isn’t gonna sweat Jim over a few late payments. She loves Jim.
No Long-Term Commitment
Jim will pay the loan back in less than 12 months. Grandma knows he’s good for it.
Risks and Considerations
Not everyone loves Jim like his Grandma. Borrowing money from a lender or institution carries inherent risk.
Higher Interest Rates
Due to the shorter repayment period, these loans often carry higher interest rates than long-term loans.
Frequent Payments
Some short-term loans require weekly or even daily repayments, which can strain cash flow.
Debt Cycle Risk
Relying on repeated short-term borrowing can lead to a cycle of debt that’s hard to break.
Collateral Requirements
Some lenders require collateral or personal guarantees, increasing the risk for business owners.
Short-Term Loans are a Current Liability
Emphasis should be placed on “current.” To avoid the risks that are inherent with a short-term loan, detailed tracking should be utilized to ensure that funds are available to prevent a short-term loan from becoming a long-term liability.
If you need help organizing your business financial obligations, contact us to learn how we can assist you.