cards because of the fee charged, it is important to remember that increasing
the pa yment options for your customers potentially increases your sales.
Accepting credit cards, rather than extending your own credit, eliminates the
need for a credit department, reduces bad debts to zero except in rare cases,
and, most importantly, allows cash to be realized sooner.
What are the company’s options for obtaining short-term financing?
Before answering this question, we need to ask a more fundament al ques-
tion. How should the external financing be split between short-term and
long-term sources of financing?
At first this may seem to be a surprising question. Perhaps you have heard
of the old adage ‘‘Finance current assets with short-term loans and fixed assets
with long-term sources of funds.’’ But this piece of folk wisdom ignores the
fact that all firms carry some permanent levels of current assets. It is unlikely
that a firm will ever carry zero receivables or zero inventory. This means
then that there is a permanent level of current assets that may be more
efficiently financed with long er term sources of funds, either equity or long-
term debt.
The company needs to analyze current asset and liability levels across the
year. What are the minimum levels of assets carried during the slack business
period? A true ‘‘maturity matching’’ approach to financing would indicate
financing the permanent levels of current assets with long-term sources of
funds. Relying too heavily on short-term debt maximizes the company’s
exposure to interest rate risk. By us ing long-term financing to finance
permanent current assets, the firm locks in a cost of funds. In periods of
rising interest rates, reliance on short-term loans can turn out to be very
expensive indeed.
The best source of financing for cyclical current asset needs is a revolving
line of credit (LOC). An LOC is essentially a preapproved loan, available on
demand in part or whole, up to the preapproved limit.
For approval, the company must submit a cash budget to the bank, which
must include months of positive cash flow and demonstrate an ability to
repay the LOC. The budget sh ould also demonstrate when and why external
financing is needed. As cash deficits occur, a check can be written against the
LOC, drawing on it to a predetermined maximum.
Internal Financial Management 321

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