Alternative Financing Policies for Current Assets

In previous sections, we looked at the basic determinants of the level of investment in current assets, and we thus focused on the asset side of the balance sheet. Now we turn to the financing side of the question. Here we are concerned with the relative amounts of short-term and long-term debt, assuming that the investment in current assets is constant.

An Ideal Case We start off with the simplest possible case: an "ideal" economy. In such an economy, short-term assets can always be financed with short-term debt, and long-term assets can be financed with long-term debt and equity. In this economy, net working capital is always zero.

Consider a simplified case for a grain elevator operator. Grain elevator operators buy crops after harvest, store them, and sell them during the year. They have high inventories of grain after the harvest and end up with low inventories just before the next harvest.

Bank loans with maturities of less than one year are used to finance the purchase of grain and the storage costs. These loans are paid off from the proceeds of the sale of grain.

The situation is shown in Figure 19.3. Long-term assets are assumed to grow over time, whereas current assets increase at the end of the harvest and then decline during the year. Short-term assets end up at zero just before the next harvest. Current (short-term) assets are financed by short-term debt, and long-term assets are financed with

Ross et al.: Fundamentals VII. Short-Term Financial 1S. Short-Term Finance of Corporate Finance, Sixth Planning and Management and Planning


In an ideal world, net working capital is always zero because short-term assets are financed by short-term debt.
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