Question

What is the impact of using long term liabilities to meet short term needs?

Answer 1

Long-Term Liabilities

Long-term liabilities are generally meant for expansion projects, research and developmental activities, etc. These borrowings consume larger processing time for sanction and involve high processing fees.

If short-term needs are met through long-term liabilities, it shows the following impact-
1. Poor working capital management by the company. The company is unable to fulfill its short-term obligations from its operating activities. The reasons could be high collection period for receivables, less inventory turnover ratio, etc.

2. High leverage and financial risk- There is a high possibility of becoming debt burden, since the source for the operational activities are long-term borrowings. The debt-equity ratio will also be high. If the company doesnot improve its working capital, then there may be erosion of equity.

3. Time and Processing cost involved- The long-term liabilities can not be obtained as steadily as the short-term liabilities. Hence, for immediate cash requirements, dependence on long-term liabilities are not worthwile.