Define Short-Term Debt

Short-term debt is a financing phrase most often associated with business accounting. However, the general definition, according to the Business Dictionary, is a debt due within 12 months, including the portion of long-term debt that is currently due. Businesses use short-term debt for various purchases and acquisitions with the intention of paying off the debt in short order.

Purpose

Short-term debt is used by companies that determine that short-term financing is a funding option preferable to investment capital or other funding sources. If a favorable interest rate on short-term financing is available, it may make sense to use it to purchase useful assets or to invest in short-term business growth. Short-term debt is a routine item included in the liabilities section of a company balance sheet.

Debt Types

In its overview of short-term debt, Bank of America notes lines of credit are a popular product used by companies that require working capital at reasonable costs. Similar to personal lines of credit, a business line of credit allows a business to secure credit to achieve a low interest rate. Paying for financing is often a more sound investment than diluting ownership to acquire new funding. If the return on investment of that financed capital is profitable, it is good use of the credit. With a line of credit, the company only uses what it needs. Other short-term fixed-rate financing methods referred to as banker's acceptances are also noted.

Benefits

Many business organizations can benefit from short-term debt if the cost is reasonable and the use of the debt makes sense. Maintenance of adequate working capital in lieu of cash flow is one common benefit sought from short-term debt. Other organizations simply use low-cost short-term debt, if available, to reinvest in other markets or business opportunities, thus profiting from the low-cost, high-return investment.

Additional Insights

While high long-term debt is closely monitored by investors, short-term debt relative to cash accounts and cash flow also is an indicator of financial health of an organization. Short-term debt that is higher than cash accounts implies the company may be in danger of not having funds to cover pending debt payments. Significantly higher cash flow relative to short-term debt usually suggests the company is in a good cash position and is simply using affordable short-term debt as working capital.