Why is debt issued in both temporary and permanent forms?

By Chizoba Morah AAA
A:

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.

RELATED FAQS

  1. How can you use a debt service coverage ratio (DSCR) to evaluate municipal bonds?

    Learn how the debt service coverage ratio (DSCR) can be used by investors to analyze the risk level of revenue bonds offered ...
  2. How is convertible bond valuation different than traditional bond valuation?

    Read about bond valuation, particularly the differences between how a traditional bond is valued and how a convertible bond ...
  3. What is the relationship between the hurdle rate (MARR) and the Internal Rate of ...

    Find out how companies and managers use hurdle rate, or MARR, and internal rate of return, or IRR, to evaluate projects and ...
  4. What is the rationale behind the effective interest rate?

    Read about the reasons why market actors identify the effective interest rate as it pertains to investing, lending and accounting.
RELATED TERMS
  1. Accelerated Return Note (ARN)

    A short- to medium-term debt instrument that offers a potentially ...
  2. Next Generation Fixed Income (NGFI) Manager

    A Next Generation Fixed Income (NGFI) manager is a fixed income ...
  3. Next Generation Fixed Income (NGFI)

    Next generation fixed income is an innovative approach to investing ...
  4. Class 3-6 Bonds

    Several classes of noninvestment grade bonds held by an insurance ...
  5. Impact investing

  6. Promotional CD rate (Bonus CD rate)

    A limited-time offer of a higher rate of return on a certificate ...

You May Also Like

Related Articles
  1. Stock Analysis

    Is it Time to Buy Floating Rate Bonds?

  2. Professionals

    Beware: These Bond Funds Act Like Stocks

  3. Mutual Funds & ETFs

    Pros & Cons Of Bond Funds Vs. Bond ETFs

  4. Mutual Funds & ETFs

    Pros and Cons: Preferred Stock ETFs ...

  5. Bonds & Fixed Income

    African Sovereign Debt: Risks and Rewards

Trading Center