Why Does a Firm Use Long Term Debt
A firm uses long term debts to maximize its financial capabilities and would eventually lead it to success.
Business owners usually need additional investments to cover various expenses within the organization or for other financial purposes.
A firm usually prefers long term debts than debts in short term for the reason of maximizing the purpose or use of the borrowed money. With long term debts, a company will be able to purchase other major investments and use the earned profit to pay for the interest of the borrowed money or pay the loan in full.
Using a long term debt, the firm may be able to take full advantage of the loaned money by using it for additional investments or to cover internal expenses. But along with the advantages are the disadvantages such as higher interest rates compared to short term debt.
An example of a long term debt is mortgage. Mortgages are usually used to finance purchase of real estates such as office buildings, factories, or other pieces of real estates. Long term debts are also helpful in purchasing additional capital assets such as machineries, equipments, and other necessary tools to make the business more profitable.
Stocks can also be considered as an area for possible long term debt. The company can monitor the stock market and sell its stocks to the stock exchange and use the profit to cover internal expenses such as expenses from business operations or to purchase additional investments.
Just like other terms, it does not always have advantage possibilities. When a firm chooses to take a long term deal, it also chooses to accept the possible disadvantages. One of the disadvantages the firm could encounter is the higher interest rates. A company should carefully study the situation first before choosing to have a long term debt. Several companies become unsuccessful due to the fact that they did not conduct substantial studies before entering into long term debt agreements. The benefits of a long term debt must be weighted against the disadvantages first. Generally, the longer the debt term is, the higher the interest rate will be. So the company must make sure that it can afford to pay the monthly interest fees of a long term debt.
The main reason on why a firm chooses to have long term deal rather than having shorter ones is because of the benefits and advantages that come with it. The company may be able to maximize the use of the loaned money by purchasing additional assets or covering up the operation expenses of a company.
A particular firm may seek advice from other consulting firm before actually entering a long term debt. A consulting firm should provide the necessary information that affects the company’s continuity. Through this the company will be able to understand the factors that are needed to be considered before choosing a long term debt.
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