Introduction
In personal finance as well as business finance payment tenure the duration that would be taken to fulfil the payment of a financial obligation is very important. Affects the cost of borrowing the ability of businesses to manage their cash resources and even the state of an economy. Hence the choice of payment tenure period can largely determine the financial impacts on persons business entities and even economies at large.
This content discusses the fact that payment tenure plays a role in finance and personal and corporate planning and investing as well as within the economy.
Effect on the Process of Budgeting
In deciding the most appropriate payment tenure for the cash flows individuals are likely to associate payment tenure with major capital acquiring decisions in their lifetime like mortgage automobile financing or credit card balances. The main factors include the amount of money paid every month which is affected by the duration of the payment tenure and the total amount of interest paid all through making up the total amount payable.
Mortgages and Loans
It is equally important to understand that shorter payment tenures while repaying mortgages imply higher monthly payments but less total interest charges. On the other hand longer tenures result in more affordable monthly payments though the total interest to be paid is also higher. This trade off is major when it comes to budget or more specifically when people are planning to buy a house. While planning for mortgage repayment many other factors need to be taken into consideration.
The decision on which of these options to take therefore depends on the financial standing of the borrower the prospects of the borrower’s stream of income and their long term financial plan. Buyers with the capacity to make higher monthly instalments may agree to take shorter tenures so as to avoid formulating large interests while those who have tight monthly cash flows may prefer to take longer tenures so that they can have small interests to meet each month.
Credit Cards and Consumer Behavior Notes
Payment tenure is most important in the case of credit card debts where people prefer to pay the minimum amount and stretch their credit card limits for a longer time. Whenever credit card issuers grant the consumer a grace period to pay for the balance the interest rate charged is relatively high meaning that extending the payment period comes at a cost.
Most consumers also tend to pay only the minimum amount which means that they never pay back the credit in full and as a result the time taken to complete the payment is relatively long hence the high cost of the debt. Psychologically long payment terms make a consumer more relaxed and this could lead to a position where the consumer has taken on more debt than he is capable of paying within the required period.
Such behaviour can result in a loan cycle when people pay back interest without being able to contribute to the payment of the capital. In the same way more concise payment tenures could be helpful for better management of credit and early reimbursement but they of course put more pressure and demand higher monthly instalments.
Short and Long Term Payment
Let’s use auto loans as an example. An auto loan allows a consumer to decide whether to take a 36 month loan or a 72 month loan. The 36 month loan will be cheaper in the long run even though the monthly instalments will be higher. Since then the interest accrued and paid will also be lower. Specifically the 72 months will have smaller monthly payments and make the car cheaper in the short run but the total interest to be paid will be much higher.
It must depend on the financial capabilities and opportunities to draft monthly payments or the actual economy when the final number of payments is smaller at shorter tenures.
Duration of Payments in Corporate Finance
Part in Corporate Debt Management
Payment tenure is always a central aspect of managing corporate debts. Many organisations use debts like bonds loans and credit lines as their sources of financing for operations and expansion. The duration of those debts impacts the company’s cash flows liquidity and financial position.
Effect on Cash Generating Capability
More extended payment tenures may be helpful to companies that seek more reasonable cash flow because it will allow them to make payments during a longer time frame. This approach is mainly helpful for companies that have long term projects that cannot be immediately exploited for profit. However longer tenures also imply that the company will pay interest for a longer period thus incurring more debt costs.
On the other hand shorter payment tenures give the company the added advantage of paying off debt enhancing its credit rating and concretizing the possibility of financial distress. Nevertheless the higher periodic payments may become more challenging to the cash flow of the company due to less reliable revenues or because the firm is in the growth phase that requires substantial reinvestment.
Various Factors in Determining Payment Tenures
Therefore payment tenures are best determined with due consideration of the length of the business cycle own sources of revenues and the state of the market. This is particularly beneficial for a firm operating in an unstable environment as it gets an opportunity to minimise long term risk as opposed to a firm operating in a more stable environment which would want to keep long term cash flows free for other investments and therefore would prefer long tenures.
For instance a tech startup may work with a short term loan with a higher monthly repayment charge but slightly more expensive than a long term obligation. On the other hand a manufacturing company that has strong financial stability fixed monthly income and a large production line would prefer to take long term affordable loans for the purpose of keeping cash reserves and continuously starting new projects.
Tenure Structure in Corporate Financing
Although a firm may have sufficient capital the way it chooses to use that capital reveals its tenure structure whereby it has time bound plans for financing the acquisition of fixed assets. Let’s take an example of a Multinational Company planning to finance a large infrastructure through the use of bonds. The important decision to be made by the company includes choosing between issuing short term bonds with a maturity of five years and long term bonds with a maturity of 20 years.
Reducing the maturity means that the short term bonds will require refinancing at shorter notice and at much higher interest rates in most probability however this will be at the expense of long term debt. The short term bonds will offer more frequent restructuring of the interest rate and thus flexibility but hypothetically the overall interest will be higher. It will depend on the company’s forecast of future interest rates and its requirement for cash flow management and the firm’s global credit standing.
If the company expects the interest rates to go high in the future then it makes sense for the firm to issue long term bonds at the current lower rates. If it believes that the rates are going to be stable or declining it might invest in short term bonds and then refinance at a later date. Erdogan (2004) states that payment tenure is one of the most critical issues that have economic implications.
Assessment of Economic Development and Stability
The fashion of payment also has enormous ramifications on the economy as a whole. The payment tenure which is reflected in the average payment duration of many sectors impacts economic growth consumer expenditure and the robustness of the economy.
Longer payment tenures are a sign of over entanglement of consumers and businesses with their credit obligations insisting on low monthly payments even for high lifetime costs. This conservative measure can have adverse effects on the rate of economic growth because people and companies may be hesitant to borrow money create new products or buy expensive items.
On the downside shorter payment tenures may be associated with a more favourable view of the economic outlook regarding consumers and businesses ability to afford higher monthly instalments in return for faster debt payoff. It can positively impact the economy from spending to investment and borrowing and stimulate the economic growth of a country.
Role of central banks
Through this it is established that central banks have a very central role to play in instilling a monetary policy that facilitates payment tenure. It can be noted that by determining interest rates central banks influence the affordability of ST and LT debt. Long payment tenure is supported when interest rates are relatively low as borrowing costs are relatively favourable. On the other hand the high interest rates cause the payment tenures to be short because the interest rates on the credit facilities are costlier.
For instance during diseconomies central banks often cut interest rates which leads to extended payment terms within the economy. In periods of economic growth when there is the likelihood of inflation the central bank can increase the interest rates which will cause the borrowers to demand shorter payment periods in order to keep the interest costs low.
Payment Tenure and Inflation
Payment tenure has an indirect relationship with inflation and this relationship may actually be more complicated. Inflation reduces purchasing power and as such a currency’s long term debt reduces with rising inflation rates. This dynamic may explain why longer payment tenures are more appealing in situations that are characterised by high inflation levels since the real cost of funds declines over time.
However as inflation also drives up interest rates payment tenures are cut short by the borrower to avoid the high costs of interest. These factors have implications when central banks are determining the interest rates and controlling inflation bearing in mind that the average payment period affects the economy.
How Industries affected through Shift Payment?
Let us think about the real estate business for instance. When interest rates are low borrowers pay more for longer terms. The majority of borrowers now choose 30 year mortgages so as to enjoy lower monthly instalments given low rates. This behaviour can act as a boost to the housing market increasing the prices of properties and thus enhancing economic growth.
However if interest rates go up the borrowers may refinance choosing short term payment tenures to avoid costs associated with interest rates which may affect the housing market and slow down economic growth.
Credit Management and Payment Period
Leung Shi & Fong (2013) proposed a conceptual framework that aims to define the risks associated with various payment tenures. Lenders pay attention to FIG because payment tenure decisions entail certain risks. Due to the existence of shorter tenors borrowers must be in a position to pay higher instalments on a monthly basis.
This might put pressure on their cash flow and hence there will be a tendency to default on repayments. Although tenure helps to reduce the monthly instalments long tenures result in a higher total cost of debt and subject the borrower to long term interest rate volatility.
Reducing Risks Associated with Payment Tenure
Risk management techniques include diversification of term structure of debt securities usage of hedging tools in case of floating rate risk and ensuring that the company has adequate cash to meet higher monthly payments in case of shorter tenure. For corporations this might mean a blend of short and long term borrowing in order to square up the cash flow requirements and keep interest costs at the lowest.
Long Term Payment Contracts
Let’s look at a firm that has borrowed funds in the long term at a fixed rate of interest. Even though this shields the company from future increases in interest rates it also means that the company is locked at the rate charged even if the market rate dips. To hedge this risk the company can engage in an interest rate risk management agreement like that of an interest rate swap to reduce the probability of paying more as compared to the benchmark interest rate.
Investors Management Techniques
Influence on Investment Decisions
The tenure of payments is a very important aspect of managing investment especially in fixed income securities such as bonds. Payment tenure is also among the key factors taken into account by the investors in order to make changes in the formulation of risk and return of an investment. For instance if there are two bonds of different maturity dates in terms of their payment tenures then the bond with a longer maturity period would attract a higher interest rate or yield due to the higher risk as a result of a longer payment tenure.
However these longer term bonds have a higher interest rate risk because their prices fluctuate greatly as interest rates change. Conversely short term bonds provide lower returns but have the least exposure to interest rate risk hence they are preferred during economic instability or when there is anticipation of an interest rate hike. When constructing an investment portfolio shareholders have to consider the higher rate of return with the extra risks involved in selected payment terms.
Impact on Asset Valuation
Other factors that affect the valuation of an asset include the payment tenure of an asset. For example choices as to bonds are highly dependent on interest rates as well as the maturity of the bond in question. When the rates of interest gain height the payments on existing bonds with longer payment tenures reduce since new bonds are issued with higher rates of returns. This shows that for bonds maturity or payment tenure has a direct bearing on how the price is affected by interest rates on the market.
Role in Portfolio Diversification
There is a lot of focus when it comes to payment tenure in some of the portfolio diversity models. Investment diversification also comes in the sense that an investor is likely to invest in a variety of securities with different payment structures in order to increase their returns while reducing risk. For instance an investor may invest in short term bills and long term corporate bonds because the former provides relative stability. In contrast the latter has relatively high returns on investment.
Fintech and Flexible Payment Options
The following are shifts in the way payment tenures are structured due to evolving technology especially in the sector. As for the payment methods the emerging fintech platforms have brought more choices for consumers and businesses to tailor the payment plan for the individual flow of cash or certain financial objectives. For example some platforms provide flexibility or variable interest rates where a borrower has to pay depending on their income or cash flow. Thus they are less prone to default.
Blockchain and Smart Contracts
It is generally agreed that blockchain technology and smart contracts will shift the existing payment tenure enforcement paradigm. A smart contract also executes and self ensures the conditions of a deal including the time and amount of payment without the interference of third parties. This technology can lead to more openness and safety when it comes to financial dealings especially in compliance with agreed payment durations.
For instance in international trade smart contracts can enable contracts to be implemented by paying for the services at certain conditions. This minimises cases of payment delays or even disputes hence enhancing the efficiency and reliability of global trade.
Future Trends of Payment Tenure
The payment tenure of the future as technology advances will also be much more dynamic and as a rule much more personalised. Other elaborate technologies such as artificial intelligence machine learning could even enhance payment perspectives by analysing data of individuals or corporations to determine the best payment terms.
Also innovation in terms of decentralised finance (DeFi) might open the door for more people to become involved in the provision of financial products where the payment system can be adapted to individual basic needs. These trends suggest that payment tenure will be constantly evolving with shifts that will better accommodate the new needs and expectations of the consumers business entities and the economy in general.
Hence financial institutions and investors will need to keep a keen eye on these technological advancements with a view to managing risks as they seek to remain relevant in the market.
Conclusion
The tenor of payments is another important parameter of finance that extends from our basic individual monetary transactions to corporate debt and overall economic stability. The factors that determine whether to take short and long payment tenures include the difference in costs between the short and long term the cash flow of the business and the credit risk.