Question

Why is it wrong: financing part or all of the temporary working capital with long-term debt

Answer 1

Answer:

Working capital is the capital, needed for day to day operations of business. Temporary working capital is the variable or cyclical working capital that is excess of working capital over the permanent working capital.

Working capital = Current assets - Current liabilities

Temporary working capital with long term debt is wrong.

Temporary Working capital financing- Temporary working capital should be finance by Short term debt not the long term debt.

Temporary Working capital financing can be done by-

• Bank credit
• Factoring
• Trade credit
• Commercial papers

Disadvantage of Temporary Working capital financing with long term debt- It can increase financial risk for the company and also the financial leverage. Long term debt has higher interest rates and fees.

Permanent working capital should be financed by Long term debt.