Short Term Financing
- Pages: 3
- Word count: 557
- Category: Economics
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As a human being, we do have needs- food, shelter, clothing, and wants- laptop, cellphone, electronic gadgets, and the like. Parents work very hard in order to earn more money to give their children what they want. This is how they finance their everyday necessities and wants. This is just like in companies wherein they will do every means they can think of just to finance their everyday operations. The need for determining the proper source in financing their assets moves into the picture of working capital management. In choosing the mix of term capital and short term debt in supporting its current assets, different factors like the availability of fund, the length of time it may be required for, the purpose of requiring the fund, the size of the firm and, the cost and risk inherent in the kind of financing sources are required to be considered. Cost and risk are inversely related, that is if a company goes for a low risk source of finance, it is related to a high cost of finance and vice versa. Hence, a prudent decision making is required. It is important to make distinctions between permanent current assets and temporary current assets in selecting the approach- aggressive, conservative or moderate of financing them that would best suit the business.
Permanent current assets which is outlined by Brigham as current assets that a firm must carry even at the trough of its cycle. Oppositely, temporary current assets are current assets that fluctuate with seasonal or cyclical variation in sales. Firms which are aggressive finances all of its fixed assets with long term capital and part of its permanent current assets with short term, non spontaneous credit( Brigham and Houston). These companies are willing to take risks since short term debts require higher return than long term debts. They maintain low levels of cash, inventories ,thus increasing profitability. But this would also mean that risk will increase since the possibility of cash shortages is high. As observed, young businessmen tolerate more risk than those who are close to retirement because they believe that there is a great earning power ahead of them. Businesses which are conservative use a small amount of short term, non spontaneous credit to meet its peak requirement.
As the word conservative suggests, firms here are known to be unadventurous or afraid to take risks but this approach sacrifices profitability. They maintain a high level of cash, holding higher level of inventory and even offer generous credit terms. The approach that threaded the middle path between aggressive and conservative policy is the moderate policy. Ordinarily, companies use short term sources in financing their short term activities such as working capital and long term sources for their capital investments in non-current assets. Short term source includes accruals, accounts payable, commercial papers and bank loans. These are more preferred to be used than long term sources because this is a faster and more flexible way for companies to obtain working capital for their daily operations especially when cash is insufficient. But short term debt has also a disadvantage because it bears greater risk than long term debt. As a conclusion, businesses must think twice if what are the sources they will be using to finance their current assets because risks and costs are associated with them.