Purchasing and Financing 2024

8. FINANCING RULES
Students understand the importance of responsible financing decisions.
The decision of how to finance an asset in a company is closely related to its expected
lifetime. Land and buildings are kept as assets for a very long time, while cash funds and
stocks are turned over quickly. Long term financing options should only be used if it will
take long to reconvert the asset into money. Consequently, fixed assets should preferably
be financed by Owner’s Equity, while loan capital should be applied to the financing of
current assets as the returns from sales can then be used to pay the creditors.
The following table explains how Assets and Financing tools should be coordinated:
RECONVERTION INTO ASSETS LIABILITIES REPAYMENT
MONEY
N/A
Cash
Long-term
Fixed Assets Land,
buildings, machinery,
long term claims
Equity capital
Loan capital
Debentures, bonds,
Long-term
Medium to short-term
Current Assets
Stocks, short-term
claims
mortgages
Trade credits, bank
overdraft
Rule: financing long-term assets with long-term means, financing
short-term assets with short-term means
Medium to
short-term
The following approaches to the financing of company assets can be distinguished:
o The Matching Approach where the period for which finance is obtained is matched
with the expected lifetime of the asset. For example, where fixed assets and
permanent current assets are financed with long-term capital.
o The Aggressive Approach where the use of short-term finance is extended to a
part of the permanent current assets (higher risk).
o The Conservative Approach where even parts of the temporary current asset are
financed with long-term capital.
38