CHAPTER FIVE

FINANCING CURRENT ASSETS

5.1. Alternative Current Assets Financing Policies
Most businesses experience seasonal and/or cyclical fluctuations. For example, construction
firms have peaked in the spring and summer, retailer’s peak around Christmas and the
manufactures who supply both construction companies and retailers follow similar patterns.
Similarly, virtually all businesses must build up current assets when the economy is strong, but
they then see off inventories and reduce receivables when the economy slacks off, still, current
assets rarely drop to zero-companies have some permanent current assets, which are the current
assets on hand at the low point of the cycle. Then, as sales increase during the upswing, current
assets must be increased and these additional current assets are defined as temporary current
assets. The manner in which the permanent and temporary current assets are financed is called
the firm’s current asset financing policy.

a) Maturity Matching, or “Self-Liquidating”, Approach

The maturity matching, or “self-liquidating”, approach calls for matching asset and liability
maturities. This strategy minimizes the risk that the firm will be unable to pay off its maturing
obligations. To illustrate, suppose a company borrows on a one-year basis and uses the funds
obtained to build and equip a plant. Cash flows from the plant (profits plus depreciation) would
not be sufficient to pay off the loan at the end of only one year, so the loan would have to be
renewed. If for some reason the lender refused to renew the loan, then the company would have
problems. Had the plant been financed with long-term debt, however, the required loan payments
would have been better matched with cash flows from profits and depreciation, and the problem
of renewal would not have arisen.
b) Conservative Approach
In this situation, the firm uses a small amount of short-term, non-spontaneous credit to meet its
peak requirements, but it also meets a part of its seasonal needs by “storing liquidity” in the form
of marketable securities.
c) Aggressive Approach
Relatively aggressive firm finances all of its fixed assets with long-term capital and part of its
permanent current assets with short-term, no spontaneous credit. There can be different degrees

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of aggressiveness. For example, all of the permanent current assets and part of the fixed assets
can be financed with short-term credit; this would be a highly aggressive, extremely no
conservative position and the firm would be very much subject to dangers from rising interest
rates as well as to loan renewal problems. However, short-term debt is often cheaper than long-
term debt, and some firms are willing to sacrifice safety for the chance of higher profits.
Permanent Current Assets can be described as assets that are supposed to be maintained by the
business over the course of time in order to ensure that the company is able to run its operations.
These assets are considered to be current assets that tend to stay persistent on the balance sheet
of the company over the course of time. Regardless of the fact that the figures within these
accounts change and fluctuate from one year to another, yet these categories of accounts will stay
intact.
However, they are still classified as current assets, because they are expected to convert into cash
over the period of the current year. In other words, they are categorized as current assets because
the time to the liquidation of these current assets is within a time frame of 12 months, and hence,
by definition of current assets, they are classified as such.
Example of Permanent Current Assets
Inventory: This mainly includes the inventory that is held by the company for purposes of
reselling (in the case where the company is a trading concern) or inventory that is in the form of
finished goods, ready to be sold to the market (if the businesses is a manufacturing concern). It
would make sense for the businesses to have inventory at any given point in time because it is
representative of the fact that the company is a going concern. Accounts Receivable: During the
normal course of the business, a lot of transactions are carried out on credit. In this case,
businesses have certain receivables that need to be collected from the customers of the business.
This is an account that is carried forward from one year to the next, and it is highly unlikely for
businesses to have absolutely no receivables at the end of the particular business year.
Cash: Cash in Bank or cash in hand is the running balance that every company needs to maintain
in order to pay day-to-day expenses. This includes petty cash, as well as all the current accounts
that the business is maintaining. It is necessary for the bare survival of the businesses, and hence,
it is considered as a permanent current asset, because it tends to exist with the business at all
times. Temporary assets can be defined as any current asset that is not pivotal for the company’s

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existence, and therefore, having those assets is good, but is not entirely essential for the survival
of the company.
Example of Temporary Current Assets
All current assets which are on a temporary basis on the balance sheet of the company are
categorized as temporary current assets. Some examples of temporary current assets are as
follows:
Seasonal inventory items: Depending on the nature of the business involved, it can be seen that
business often has inventories that are not really finished goods, but are kept either to upsell
inventory or for packaging purposes. Therefore, since they are only present with the company for
shorter time duration, they are classified as temporary current assets. Prepaid Rent (or any other
utility): It often occurs that businesses pay an excess of utility, or rent, during the normal course
of the business. Hence, in this regard, it is quite important to note that these prepaid entries are
considered to be temporary, since they do not always exist on the books, and only occur
occasionally. Therefore, these current assets are categorized as temporary current assets, because
they may or may not be carried forward from one year to another.
Permanent Current Assets vs Temporary Current Assets
The underlying difference between permanent current assets and temporary current assets is the
fact that temporary current assets, as suggested by the name, are current asset classes that exist
on the financials for a short while. A business may, or may not have temporary current assets at
the end of a given financial year. Just like permanent current assets, they are assets the utility of
which is expected to be derived within a period of 12 months. Hence, it is classified as a current
asset. In the same manner, it can also be seen that temporary current assets tend to fluctuate with
time, and may or may not exist, at all on the balance sheet.
5.2. Short-Term Financing
Short-Term Financing is a need for money for a short period of time, i.e., less than a year. It is
one of the primary function of finance that manages the demand and supply of capital for an
interim period, and these funds can be secured or unsecured. To use such funds total financing
funds should be driven by the company, and the company gets directed by the risk-return trade-
off for this decision.
Sources of Short-Term Financing
1) Trade Credit

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Trade Credit is also known as accounts payable; it is a credit drawn out by one seller to another
when a credit purchase has been made, it helps in supplying goods without immediate payment
of cash. It provides a floating time of 28 days to manage the cash flow of the business. Thus, it is
widely used by business firms as a source of short-term finance, the amount of trade credit relies
upon the purchase units for which credit is available. Although it may be risky for the supplier if
the buyer does not pay the sum in due course, and to avoid such losses the other set of trade
credit is required in which instruments such as promissory notes, bills of exchange are needed.
So that in case the supplier needs money, he can discount such bills from the banks. The bills of
purchase having a high credit rating can be sold. These instruments minimize the risk of bad
debts.
2) Bank Finance
Corporate sector is very much dependent on the commercial bank for fulfilling their short-term
financial needs, a limited portion of this need gets fulfilled by the trade credit, and the excess
requirement over it gets fulfilled by a commercial bank. Bank credit has two forms, i.e.,
unsecured and secured credit. Unsecured credits are those that are not covered by collateral
securities, and collateral securities cover secured Credits.
Loan can be provided with either for a specific purpose known as a single loan for which the
company signs a promissory note to avoid deficiencies and repays this loan within a specific
period of time. On the contrary, the other way of granting a loan is a line of credit which is more
common; the bank fixes a limit for the borrower to avoid the cumbersome process of going
through essential formalities every time the borrower reaches a bank for a loan.
The ways of borrowing a sum from the bank are as follows:
 Working capital loan
 Discounting of bill
 Overdraft
 Letter of credit
 Cash credit
3) Accrued Expenses
The expenses which have already been acknowledged in the books before it has been paid are
known as accrued expenses.
4) Deferred Revenues

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Deferred revenue refers to a part of the firm’s income that has not been acquired, but prepayment
has already received by the customers.
5) Commercial Papers
Issuing of commercial papers is also one of the most used sources of financing now-a-days.
These are the short-term notes describing that if a company needs money, they can issue
commercial papers. It is used for financing of Trade credits, payroll and meeting additional
short-term liabilities and commercial paper ranges from 15 days to 1 year.
6) Letter of Credit
The Letter of Credit shows the pledge of the buyer to the seller for making the payment. This
document is issued by the bank, safeguarding the prompt and full payment to the seller. If the
buyer fails to do so, the bank becomes liable to pay the amount to the seller, for issuing a letter of
credit bank charges a percentage of the amount from the buyer and is delivered against the
pledge of securities.
Advantages of Short-Term Financing
 Easy to Obtain: Creditors make short-term funds easier to obtain as the risk involved in
delivering loan varies according to payment time.
 Less Risky: In Comparison with long-term financing, short-term financing is less risky,
as creditors grant credit for a short period of time.
 Resilience: Short-term financing provides resilience as the borrower may adopt
alternative sources of credit after negotiating the short-term credit account by debtors.
Disadvantages of Short-Term Financing
 Mature More Frequently: Firm’s producing capital goods worries more often about
short-term creditors as they produce slow-moving inventories, and short-term financing
creates a tight position for a firm more often. If short-term liabilities do not get settled
timely, the creditors may demand closure of the firm.
 Costly: When general economic outlooks and collateral elements are considered, short-
term finances at times look costlier than long-term finances.

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