Short Term and Long Term Debt Financing

The aim of this paper is to propose two sources of short term and long term debt for Ditchling Ltd. The paper will seek to identify the reasons of finance in the company and suggest the most appropriate sources based on those reasons.

2.0 BUSINESS BACKGROUND

Ditchling Ltd is a Residential Care Service which is registered and regulated by the Care Quality Commission. It delivers professional high quality support services to adults with learning disabilities and associated challenging behaviour in West Sussex. Ditchling Ltd is a specialist organisation supporting people with many types of disability, including: Autistic Spectrum Disorders and Asperger's Syndrome, Disabilities associated with Epilepsy, Specific syndromes such as Down's, Angelman's and Cri du Chat, Mental health diagnoses such as Schizo-affective Disorder, Bi-Polar Mood Disorder, Obsessive Compulsive Disorder, Depression and Adults who exhibit challenging behaviour due to communication difficulties and learning history. The primary objective of Ditchling Ltd is to enhance and promote service users' independence and life skills through; offering access to on-site day service which includes horticulture and animal husbandly and accessing local colleges, health and medical facilities, social clubs and other community amenities. Provision of care and the above support services should be done without compromising the financial sustainability of the business. Subject to regulation 13 of the Care Quality Commission the service provider must take all reasonable steps to provide the service in such a manner as to ensure the financial viability of the carrying on the business [1] . In pursuant to its objectives, Ditchling Ltd is currently being faced with three major issues that need attention in terms of financing Payment of wages on time Marketing the company's on-site day service Constructing an annex/extension to the main house to serve as an administrative hub

3.0 DEBT FINANCING

According to Ward, S (2007) Debt financing is money that a company borrows to run its business. Debt financing can be divided into two categories; long term debt financing and short term debt financing.

3.1 SHORT TERM DEBT FINANCING

Short Term Debt Financing usually applies to money needed for the day-to-day operations of the business, such as purchasing inventory, supplies, or paying the wages of employees. Short term financing is referred to as an operating loan or short term loan because scheduled repayment takes place in less than one year. Short term financing includes; working capital loans, overdrafts, commercial papers, leasing and trade credit.

3.1.1 Overdraft

Overdraft financing occurs when businesses make payments from their business current account exceeding the available cash balance. When a business makes a prior agreement with the bank for an overdraft facility, and the amount overdrawn is within this authorised overdraft, then interest is normally charged at the agreed rate. If the balance exceeds the agreed terms, then fees may be charged and higher interest rate might apply. Ditchling needs to take advantage of this facility so as to address its cash-flow difficulties and also to ensure there are funds available to pay its wages to employees. Wages are normally paid after 4 weeks. However, the remittances to Ditchling from the clients' financiers are done at the end of the calendar month. This means that sometimes the company is forced to delay wages if there is insufficient funds in the account. There have also been cases of bounced pay cheques. This has made the staff members lose confidence with the management with some contemplating seeking legal redress An overdraft facility will allow Ditchling to pay wages by drawing pay cheques that exceed the available balance. This gives the bank account a negative balance but within the agreed limit. This will also reduce hefty charges incurred from un arranged overdrawing of the account and fines from unpaid items due to lack of sufficient funds. Once the client funding authorities or financiers pay at the end of the month, the account will swing back to credit and no further charges will be incurred for utilising the overdraft.

3.1.2 Working Capital Loan

Another short term debt that the company should utilise is s working capital loan. This is a short term loan from the bank to boost the working capital of the company. The working capital is the net assets a company has after deducting current liabilities from the current assets. The current assets in Ditchling Ltd's case are short term sources of finance such as debtors, cash and cash equivalents. Cash equivalents are short term and highly liquid investments which are easily and immediately convertible into cash. A working capital loan will boost the current assets by increasing the amount of cash at hand and in bank to pay off for the marketing expenses and advertising costs that are related to the day service. This includes production of fliers and adverts in the print and electronic media. Repayment should be within one year. Monitoring is done by both the company and the bank through a loan repayment schedule and maintenance of proper accounts

3.2 LONG TERM DEBT FINANCING

Long Term Debt Financing usually applies to assets the business is purchasing, such as equipment, buildings, land, or machinery. With long term debt financing, the scheduled repayment of the loan and the estimated useful life of the assets extends over more than one year. Sources of long term financing include; Bank Loan, Loan notes or Debentures, Deep discount bonds, Zero coupon bonds and Convertible loan notes.

3.2.1 Bank Loan

The directors should approach a financial institutions preferably a bank and apply for a business loan to finance the construction of building to be used as the administration centre. These loans are term based, which may vary from three to ten years. The amount, the tenure and interest rates may vary depending upon Ditchling Ltd's risk profile. Term loans are either asset-backed or cash-flow backed. In the case of asset-backed term loans, lender institutions seek assets of the company as collaterals while issuing loans. In the case of cash-flow backed loans, banks carefully scrutinize the balance sheets of a company to study its cash-flow capability. Fraser MacKay of Barclays' Business Banking service says 'loans are very flexible tools. They can be utilised for a wide range of projects, be it expansion, product development, purchase of assets and even for working capital if you are moving to new premises.' Stephen Pegge, of LloydsTSB Business concurs that 'one of the attractions of a business loan is that, as opposed to say, attracting equity investment, you are not selling a part of your business to grow. You retain 100 per cent and don't have to worry about outside partners or dividends.' The total cost of the annex/extension has been calculated to £50,000. The company has mainly been using its own funds as opposed to borrowing hence it has low gearing. The principal and interest payments on a business loan are classified as business expenses, and thus can be deducted from business income taxes which will be beneficial to the business. Ditchling can offer to pay the loan over a period of time say over 5 years and could also give collateral to the bank form one of its assets. The security offered should adequately cover the proposed exposure. Its marketability should also be good and not easily affected by any foreseeable factors

3.2.2 Mortgage Debenture

Another long term debt at the directors' disposal is issuing of a debenture. A debenture is a medium- to long-term debt instrument used by companies to borrow money. According to Riley, J (2009) debentures issued in UK have to be secured. A secured debenture is one that is specifically tied to the financing of a particular asset such as a building. Then, just like a mortgage for a private house, the debenture holder has a legal interest in that asset and the company cannot dispose of it unless the debenture holder agrees. In this case, because the debenture is for a building it is a mortgage debenture. The directors could issue "10% debentures 2013/2015 £50,000". This means, the debentures will be redeemable between 2013 and 2015 at the fixed interest rate of 10% In conclusion, Ditchling Ltd continuing to operate with no debt or leverage may be missing an opportunity to increase earnings by financing operations and projects that will give a better return than the cost of the debt. A little debt can be good for the company's earnings.

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