Financial Management · Sources of, and raising, business finance

Short-term vs Long-term Sources of Finance for ACCA Financial Management

Updated 11 October 2026 · Fact-checked

Short-term finance (overdrafts, trade credit, short-term loans) is repaid within about a year and funds working capital. Long-term finance (term debt, leasing, equity) funds non-current assets and growth. Match the maturity of the finance to the life of the asset, then weigh cost, risk, flexibility, security and control.

Understand Short-term vs Long-term Sources of Finance

Every business needs money to run day to day and to invest for the future. Finance is split by maturity, meaning how long until it must be repaid. Short-term finance is normally due within one year. Long-term finance is due after more than one year, or never, as with ordinary shares.

Short-term sources include bank overdrafts, trade credit from suppliers, short-term bank loans and factoring or invoice discounting. An overdraft is flexible and you pay interest only on the amount used, but the bank can ask for repayment on demand. Trade credit looks free, but it is not if you give up an early settlement discount. Its cost is usually high when you skip the discount.

Long-term sources include bank term loans, bonds and loan notes, leasing, preference shares, ordinary shares and retained earnings. Debt has a contractual interest cost and usually ranks ahead of shareholders on liquidation. Interest is normally tax-deductible, so debt is generally cheaper than equity. But it adds financial risk, because interest must be paid whether or not profits are made. Equity has no fixed payment and no repayment date, but shareholders want a higher return because they carry more risk. Dividends are not tax-deductible.

Leasing sits between the two. An operating lease is a short-term rental, with the lessor keeping the risks of ownership. A finance lease runs for most of the asset's life and works like a loan to buy the asset.

The key idea is matching. Fund permanent assets with long-term finance and fluctuating needs with short-term finance. Using short-term money for long-term assets risks a cash crisis when it must be renewed. Using long-term money for short-term needs is safer but costs more, as long-term funds are usually dearer and may sit idle. Cheap, flexible short-term finance carries refinancing risk. Long-term finance gives security but less flexibility.

Key rules to remember

Cost of giving up an early settlement discount (annual): (1 + d ÷ (100 − d))^(365 ÷ (T − t)) − 1; d = discount %, T = normal credit days, t = discount days. The simple version is d ÷ (100 − d) × 365 ÷ (T − t). Use the compound version unless told otherwise.
Cost of one period of foregone discount: d ÷ (100 − d); This is the periodic cost of paying late instead of taking the discount.
Matching principle: Long-term assets → long-term finance; fluctuating current assets → short-term finance; A rule of thumb, not a law. Aggressive and conservative policies depart from it deliberately.
Gearing (debt/equity): Debt ÷ Equity (or Debt ÷ (Debt + Equity)); Say which version you use. Higher gearing means higher financial risk.

How to solve Short-term vs Long-term Sources of Finance questions

Use this method for any question asking you to compare or recommend sources of finance.

1Identify the need: how much, for how long, and for what (working capital or a non-current asset).
2Apply matching: pick short-term finance for temporary needs and long-term for permanent needs.
3List the realistic sources for that company's size and status. A small unlisted firm cannot issue bonds or shares to the public easily.
4Compare each source on cost, risk, flexibility, security required, repayment terms and control or dilution.
5Calculate where asked, for example the cost of foregoing a discount or the effect on gearing and interest cover.
6Check constraints in the scenario: existing covenants, gearing levels, tax position, cash flow pattern.
7Make a clear recommendation and give the reason tied to the scenario.
8Mention the main drawback of your choice so the answer is balanced.

Quickest way: Need, term, cost, risk

When to use it: Use this for Section A and OT case questions where you must pick one option quickly.

Underline the purpose and period in the question.
Eliminate options whose maturity does not match the need.
Eliminate sources the company cannot access, such as a stock market issue for a small private firm.
If two remain, choose on the stated priority: lowest cost, lowest risk, no dilution or fastest to arrange.
For discount questions, go straight to d ÷ (100 − d) and compound it over the number of periods in a year.

Common mistakes in Short-term vs Long-term Sources of Finance

Treating trade credit as free finance.
No interest is shown on the invoice.
Fix: Calculate the cost of losing the early settlement discount. It is often far higher than overdraft interest.
Recommending equity because it has no fixed payments, ignoring its higher cost.
Students focus on risk and forget that shareholders require higher returns and dividends get no tax relief.
Fix: State both sides: equity lowers financial risk but costs more and dilutes control.
Funding a long-term asset with an overdraft.
Overdrafts look cheap and easy.
Fix: Point out the refinancing risk. The bank can withdraw an overdraft on demand, so match maturity to the asset's life.
Using the simple annual cost of a discount when the question expects compounding, or the reverse.
Both versions are taught.
Fix: Use the compound formula unless the question says simple. State your method.
Using the wrong number of days in the exponent.
Students use the full credit period instead of the extra days gained.
Fix: Use T − t, the days between discount date and normal due date, not T.
Giving generic lists in written answers without linking to the scenario.
Students recall notes rather than apply them.
Fix: Tie each point to figures or facts given, such as current gearing, asset life or the company's size.

Worked examples

Example 1

A supplier offers 2% discount for payment within 10 days, otherwise payment is due in 40 days. Calculate the effective annual cost of not taking the discount (compound basis, 365 days). Round to one decimal place of a percent.

Show the solution

Periodic cost = 2 ÷ (100 − 2) = 2 ÷ 98 = 0.020408.
Extra days of credit = 40 − 10 = 30 days.
Periods per year = 365 ÷ 30 = 12.1667.
Annual cost = (1.020408)^12.1667 − 1.
ln(1.020408) = 0.020204. Multiply by 12.1667 = 0.24583.
e^0.24583 = 1.2788, so the cost is 0.2788, about 27.9%.

Answer: About 27.9% a year. If the company can borrow below this, for example on an overdraft, it should take the discount.

Example 2

A growing private company needs ₹50,00,000 for a machine with a ten-year life and ₹8,00,000 for a temporary rise in inventory over the next four months. Recommend suitable finance for each need.

Show the solution

Machine: a permanent, long-term need over ten years, so match with long-term finance.
Options: a bank term loan or a finance lease over about the asset's life. Both avoid issuing shares and keep control with existing owners.
Check risks: a loan adds fixed interest and may need security. The machine can act as security, and a lease reduces the upfront cash needed.
Inventory: a temporary need of four months, so short-term finance fits.
Option: an overdraft, because it is flexible and interest is paid only while used. Trade credit extension is another low-cost option if suppliers agree and discounts are not lost.
Warn that an overdraft is repayable on demand, so the company should agree a facility limit in advance.

Answer: Use a term loan or finance lease for the machine and an overdraft (or extended trade credit) for the temporary inventory. This matches maturity to need.

Exam tips

In OT questions, check the time period first. Many wrong options fail only on maturity matching.
For written answers, use a short structure per source: cost, risk, flexibility, security. Then link to the scenario.
Always give the discount cost calculation with working. Method marks matter in constructed response, and OT answers are all or nothing.
Quote the company's stated position, such as high gearing or a small unlisted status, when recommending finance.
Make a clear recommendation. Listing pros and cons without choosing loses marks.

Practice questions from Sources of, and raising, business finance

Short-term vs Long-term Sources of Finance in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Short-term vs Long-term Sources of Finance: frequently asked questions

What is the difference between short-term and long-term finance?

Short-term finance is repayable within about a year and funds working capital. Long-term finance is repayable after more than a year, or is permanent like equity, and funds non-current assets and growth. The split is by maturity.

Why is debt usually cheaper than equity?

Lenders have a prior claim and fixed returns, so they accept lower returns than shareholders. Interest is also normally tax-deductible, while dividends are not. The trade-off is higher financial risk from fixed payments.

How do I choose between debt and equity in ACCA FM?

Compare cost, risk, control, gearing level, security available and access to markets. Debt suits stable cash flows and low current gearing. Equity suits high gearing, uncertain profits or a need to avoid fixed commitments.

Is leasing short-term or long-term finance?

It can be either. An operating lease is a shorter rental where the lessor keeps the risks of ownership. A finance lease covers most of the asset's life and is treated much like long-term borrowing.