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Short-Term Debt: Understanding Its Importance in Business and Financial Planning

Abanti Chattopadhyay

5 min Read

27 Dec 2020

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Introduction

Short-term debt refers to financial obligations that mature in less than one year, though in some cases, debts with maturities of up to three years are also considered short-term. These debts are categorized as current liabilities on a company’s balance sheet due to their urgent nature.

Businesses, governments, and individuals use short-term debt for immediate financing needs, working capital management, and operational expenses. While short-term debt provides quick access to funds, it also requires careful planning to avoid liquidity risks.

This article explores the definition, types, advantages, risks, and management strategies of short-term debt in India, along with its role in business and personal finance.

What Is Short-Term Debt?

Short-term debt is any loan or financial obligation that must be repaid within a short period, usually less than a year. In business accounting, it appears under current liabilities on the balance sheet.

Examples of short-term debt include:

Short-term bank loans – Borrowed funds from banks with repayment due in a year.
Trade credit or accounts payable – Money owed to suppliers for goods/services.
Overdraft facilities – Borrowing allowed beyond available bank balances.
Commercial paper – A short-term debt instrument issued by corporations.
Wages and salaries payable – Compensation due to employees.
Tax liabilities – Income tax, GST, or other government dues.
Lease payments – Rent or leasing costs that are due within the year.

For example, if a company borrows ₹10 lakh through a working capital loan for six months, it is classified as short-term debt since it must be repaid within a year.

Types of Short-Term Debt

1. Bank Loans and Overdrafts

Bank overdrafts allow businesses to withdraw more than their account balance, providing liquidity.
Short-term bank loans offer quick financing for operational needs.

2. Trade Credit (Accounts Payable)

Companies purchase goods or services on credit, deferring payment for a few months.
Common in business-to-business (B2B) transactions.

3. Commercial Paper (CPs)

A short-term unsecured promissory note issued by companies for working capital.
Typically issued for 7 days to 1 year and used by large corporations.

4. Treasury Bills (T-Bills)

Short-term government debt securities issued by the Reserve Bank of India (RBI).
Maturity periods: 91 days, 182 days, and 364 days.

5. Short-Term Bonds and Debentures

Bonds with maturities below 3 years are sometimes considered short-term debt.
Used for temporary financing by governments and companies.

6. Wages, Salaries, and Taxes Payable

Unpaid salaries or wages due to employees within the financial year.
GST, corporate tax, and other statutory dues also fall under short-term debt.

Advantages of Short-Term Debt

1. Quick Access to Funds

Short-term loans and credit lines provide immediate liquidity for businesses and individuals.

2. Lower Overall Cost Compared to Long-Term Loans

Since short-term debts are repaid quickly, companies avoid long-term interest burdens.

3. Flexible Repayment Structure

Short-term debt can be repaid or rolled over based on cash flow conditions.

4. Helps Maintain Working Capital

Businesses rely on short-term financing to pay suppliers, employees, and manage daily operations.

5. Limited Long-Term Liability

Unlike long-term debt, short-term borrowings do not burden companies with extended financial commitments.

Risks and Challenges of Short-Term Debt

1. High Interest Rates

Short-term loans often come with higher interest rates than long-term financing.

2. Liquidity Risk

If a company or individual cannot repay short-term debt on time, it can lead to financial distress.

3. Dependency on Market Conditions

Availability and cost of short-term credit depend on economic conditions and RBI policies.

4. Frequent Refinancing Requirements

Businesses may need to roll over short-term debt frequently, leading to financing instability.
For example, if a company relies heavily on bank overdrafts, a sudden increase in interest rates can strain cash flows.

Short-Term Debt Management Strategies

1. Maintain a Cash Flow Forecast

Companies should ensure that they have enough liquidity to meet short-term obligations.
Individuals should plan loan repayments alongside monthly expenses.

2. Diversify Credit Sources

Avoid dependence on a single lender by using multiple credit facilities such as trade credit, commercial paper, and bank overdrafts.

3. Monitor Debt-to-Equity Ratio

Businesses should limit short-term borrowing to prevent excessive leverage.

4. Negotiate Favorable Terms with Lenders

Companies can reduce borrowing costs by negotiating lower interest rates or extended repayment periods.

5. Use Short-Term Debt for Revenue-Generating Activities

Loans should be used for inventory purchases, seasonal sales, or short-term expansion, not speculative investments.
For example, a retail business borrowing ₹5 lakh for seasonal stock purchases can repay the loan from sales revenue.

Short-Term Debt in India: Regulatory and Market Trends

1. RBI Regulations on Short-Term Borrowing

RBI regulates bank lending and corporate debt instruments to ensure financial stability.
Commercial papers must be rated by credit rating agencies like CRISIL, ICRA, and CARE Ratings.

2. SEBI Rules on Short-Term Bonds and Commercial Paper

SEBI ensures that corporate debt instruments maintain transparency and investor protection.
Companies must disclose repayment schedules in financial reports.

3. Growth of Fintech-Based Short-Term Loans

Digital lending platforms now offer quick, unsecured short-term loans to businesses and individuals.
Example: Buy Now, Pay Later (BNPL) schemes, MSME working capital loans.

4. Increasing Use of Treasury Bills for Government Borrowing

The Government of India issues short-term T-bills to manage fiscal deficits and liquidity needs.

Conclusion

Short-term debt is an essential financing tool for businesses, governments, and individuals, providing immediate liquidity and financial flexibility. However, high interest rates and repayment risks make careful debt management crucial.

Investors, businesses, and policymakers must balance short-term borrowing with long-term financial planning to ensure sustainable growth and financial stability in India’s evolving economy.

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