Class_content__13.1_Explain_the_Pricing_of_Long-Term_Liabilities_-_Principles_of_Accounting__Volume_

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2/10/22, 10:02 PM13.1 Explain the Pricing of Long-Term Liabilities - Principles of Accounting, Volume 1: Financial Accounting | OpenStax1/15Businesses have several ways to secure financing and, in practice, will use a combination ofthese methods to finance the business. As you’ve learned, net income does not necessarilymean cash. In some cases, in the long-run, profitable operations will provide businesses withsufficient cash to finance current operations and to invest in new opportunities. However,situations might arise where the cash flow generated is insufficient to cover future anticipatedexpenses or expansion, and the company might need to secure additional funding.If the extra amount needed is somewhat temporary or small, a short-term source, such as aloan, might be appropriate. Short-term (current) liabilities were covered inCurrent Liabilities.When additional long-term funding needs arise, a business can choose to sell stock in thecompany (equity-based financing) or obtain along-term liability(debt-based financing), suchas a loan that is spread over a period longer than a year.Types of Long-Term FundingIf a company needs additional funding for a major expenditure, such as expansion, the sourceof funding would typically be repaid over several years, or in the case of equity-basedfinancing, over an indefinite period of time. With equity-based financing, the company sells aninterest in the company’s ownership by issuing shares of the company’s common stock. Thisfinancing option is equity financing, and it will be addressed in detail inCorporationAccounting. Here, we will focus on two major long-term debt-based options: long-term loansand bonds.Debt as an option for financing is an important source of funding for businesses. If a companychooses a debt-based option, the business can borrow money on an intermediate (typicallytwo to four years) or long-term (longer than four years) basis from lenders. In the case ofbonds, the funds would be provided by investors. While loans and bonds are similar in thatthey borrow money on which the borrower will pay interest and eventually repay the lenders,they have some important differences. First, a company can raise funds by borrowing from anindividual, bank, or other lender, while a bond is typically sold to numerous investors. When acompany chooses a loan, the business signs what is known as a note, and a legal relationshipcalled anote payableis created between the borrower and the lender. The document lists theconditions of the financial arrangement, a fixed predetermined interest rate (or, if theagreement allows, a variable interest rate), the amount borrowed, the borrowing costs to becharged, and the timing of the payments. In some cases, companies will secure aninterest-only loan, which means that for the life of the loan the organization pays only the interestexpense that has accrued and upon maturity repays the original amount that it borrowed andstill owes. For individuals a student loan, car loan, or a mortgage can all be types of notespayable. For Olivia’s car purchase inWhy It Matters, a document such as apromissory noteis typically created, representing a personal loan agreement between a lender and borrower.

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