Question

Explain how different amounts of current assets and current liabilities affect firm’s profitability. What does it mean to adopt a maturity matching approach to financing current assets?

Answer 1

The maturity matching, or “self-liquidating,” approach calls for matching asset and liability maturities.  All of the fixed assets plus the permanent current assets are financed with long-term capital, but temporary current assets are financed with short-term debt.  A more aggressive financing approach would involve financing some of its permanent assets with short-term debt.  The reason for adopting the aggressive policy is to take advantage of the fact that the yield curve is generally upward sloping, hence short-term interest rates are generally lower than long-term rates.  A more conservative financing approach would involve financing all permanent current assets as well as some of its seasonal needs with long-term capital.  In this situation, the firm uses a small amount of short-term 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.  This is a very safe, conservative financing policy.