What Is Short-term Debt ?

Short-term debt, also known as current liabilities or short-term liabilities, is a company's financial obligations that are due to be paid off within a year or less. These debts are typically associated with operational expenses, such as the cost of goods sold, payroll, taxes, and other expenses that are incurred as part of a company's daily operations.

Examples of Short-term Debt

• Bank Overdrafts: Allows businesses to withdraw more money than they have in their account up to a certain limit.
• Commercial Paper: A form of unsecured, short-term debt instrument issued by corporations, typically used for the financing of payroll, accounts payable and inventories, and meeting other short-term liabilities.
• Trade Credit: This occurs when one business provides goods or services to another on credit terms (e.g., pay in 30 days).
• Short-term Loans: Loans that need to be repaid within a year, often used for immediate business needs.

Why is Short-term Debt Important?

Short-term debt plays a crucial role in a company's financial health for several reasons:

• Flexibility: It offers businesses the flexibility to quickly access funds for immediate needs without committing to long-term debt obligations.
• Cash Flow Management: Helps companies manage their cash flow more effectively, ensuring they have the funds necessary for day-to-day operations.
• Opportunity Costs: Short-term borrowing can be less expensive compared to long-term debt, especially if the funds are needed for a brief period, reducing the opportunity cost of using the company's own cash.

Example: Infosys

Let's consider Infosys, a prominent Indian IT company. If Infosys needs to upgrade its software for employees across different locations, it may opt for short-term debt to finance this urgent expense. The company could take out a short-term loan or use a bank overdraft to cover the cost, planning to repay the borrowed amount with revenue generated from its operational activities over the next few months.

Risks of Short-term Debt

While short-term debt can be beneficial, it also carries certain risks:

• Higher Interest Rates: Short-term loans often come with higher interest rates compared to long-term debt, making them more expensive in the short run.
• Repayment Pressure: The need to repay debts within a short period can pressure a company's cash flow, especially if the business faces unexpected downturns.
• Dependency: Over-reliance on short-term debt can lead companies into a cycle of perpetual borrowing, which may hinder long-term financial stability.

In summary, short-term debt is a critical financial tool that companies and individuals can leverage for immediate funding needs. However, it's essential to balance its use with an understanding of the associated costs and risks. By managing short-term debt wisely, entities can maintain liquidity, sustain operations, and position themselves for long-term success.