2018-01-08

What Justifies a Firm’s Use of Long Term Loans — Advantages and Disadvantages

Wondering what a long term loan is? It is basically a form of debt that you are supposed to pay over an extended time period, but this time frame should extend the duration of one year. A business gets this loan so that they can buy assets, equipments and inventory or to get additional income for the operations. Some of the common examples of long term loans are boat loans, car and auto loans, equity loans, mortgages, personal loans, and student loans.

Coming back to the question, is it ever a bad time to go for long term loans? Well, everything has its own set of advantages and disadvantages, so let’s have a look at them from a business’s perspective:

Advantages of Long Term Loans

If you look at it from the firm’s perspective, long term financing has a number of advantages. They are:

Debt Not Costly

The debt is not at all costly. The reason why it is not costly is that the interest of debt is tax deductible and secondly, a lot of investors consider this to be a less risky investment, since it has a low return rate.

Flexibility

Another advantage is that it provides flexibility in the financial model of the company. This flexibility can be increased with the help of insertion of call provision in the bond structure. It is important to know that in case of over capitalization; the company can make use of the debt so that they can balance the capitalization.

Lack of Interference

Another great advantage is that there is no interference in your business operations, because the bond owners are basically creditors, and they don’t have a right to vote and meddle with your business.

Tax Saving

Your company will get a chance of saving tax on interest on debt.

Budget

The budget allows you to buy things that would not have been possible without the long term loan. The debt gives you a chance to work to stay in touch with the lender, so that you can find out how much you can pay back every month in the long term.

Disadvantages of Long-Term Loan

There are certain disadvantages related to long term loans. Let’s have a look at them from the firm’s point of view:

Interest

Remember that interest is always a burden because the company has to pay it to the bondholders. The problem is that the company has to pay this amount, irrespective of the fact that whether they are receiving any profits or not.

Maturity Date

Another disadvantage is that long term loans have a fixed maturity, which means that the investor has to reinvest their money once the bond has reached its maturity.

Risky

The debt makes this source of financing extremely risky. The company has to pay the interest in the given period of time because non-payment can result in bankruptcy.

In conclusion, you should weigh the advantages and the disadvantages before going for a long term loan.

Paul Gonzalez