Debt is separated into two categories:
1) Temporary or short-term
2) Permanent or long-term.
Temporary or
short-term debt refers to debt with a maturity of less than one year. This means that the debt is due to be paid in less than one year. This could be a one-day limit a term of just a little less than 12 months. A company issues short-term debt if it is in immediate need of liquid cash and cannot access it. Common examples of short-term debt are
T-bills, loans and
commercial paper. Permanent or
long-term debt, by contrast, refers to debt that has a maturity period of 12 months or more. That means the company has over a year to pay back the debt. Common examples of long-term debt are loans, mortgages, and bonds.
Short-term debt often includes the smaller payments on long-term debt. Long-term debt payments a specific sum of money that is due monthly or at the end of a time period that is less than 12 months. The sum of money that is due monthly is included in short-term debt. For example, a company has $150,000 in long-term debt and $5,000 is due every three months. In its books, the company records the payments due within the next 12 months as short-term debt. (To learn more, check out
Reading The Balance Sheet.)
As to why debt is issued in these two separate forms, short-term debt is meant to finance operations on a day-to-day level. For example, a company is in a seasonal business like selling lawnmowers may need short-term debt to cover payroll, leasing costs, materials and so on until its product or service begins to sell. The proceeds then go to paying the short-term debt down. Permanent or long-term debt is used to purchase assets that will take over a year, and more likely several years, to pay for themselves. The same lawnmower company would use long-term debt to finance the building of a larger factory, again paying it back over the years from increased profits due to increased production.
This question was answered by
Chizoba Morah.
