Question

By using long-term financing to finance part of temporary current assets, a firm may have less risk but lower returns than a firm with a normal financing plan. Explain the significance of this statement.

Short answer

Long-term financing is an expensive financing method, which will lower the organization’s profits.

Step-by-step solution

Meaning of long-term financing

Long-term financing refers to the financing taken by an organization for more than one year. This financing option is taken to fulfil the long-term financial requirements of the organization.

The significance of the given statement

If the company uses long-term financing for its current temporary assets, it will provide the necessary funds in the long term, but the cost of long-term financing is higher than that of short-term financing. So, the profits generated by the organization will be lower when utilizing long-term financing.