Question

A firm that uses short-term financing methods for a portion of permanent current assets is assuming more risk but expects higher returns than a firm with a normal financing plan. Explain.

Short answer

Short-term financing is available at lower interest rates than that of long-term financing, resultingin higher profits for the organization.

Step-by-step solution

Meaning of short-term financing

Short-term financing is the process of using different sources of finance for obtaining finance for less than one year. This method is usually used to meet the working capital requirements of the organization.

The explanation of the given statement

Short-term financing is offered at lower interest rates than the sources of long-term financing. If this method is used for permanent assets, it would be risky as the finance may not available at all times, but the cost of this method of financing will be low, resulting in higher profits for the organization.