Question

What does it mean to adopt a maturity matching approach to financing assets, including current assets? How would a more aggressive or a more conservative approach differ from the maturity matching approach, and how would each affect expected profits and risk? In general, is one approach better than the others? Use your industry for illustration.

Answer 1

Answer:

Check the following definitions

Explanation:

a. Maturity matching simply means that long term funds should be used to finance long term assets and short term funds should be used to finance short term assets.

That means, long terms funds will finance fixed assets and permanent working capital while short term funds will finance temporary working capital.

If permanent assets are financed with short term funds, then refinancing risk arises, i.e. borrower has to refinance the loan at its maturity date which is of a shorter period. On the other hand if long term funds are used to finance short term assets, then interest has to be paid for the longer period when funds are not even used.

b.

Aggressive approach :

Under the aggressive approach, the firm finances all temporary current assets and some of its permanent current assets with short-term sources of financing. This approach relies more heavily on short-term financing than the other approaches. This brings a little refinancing risk and decrease in profits as short term funds are costlier than long term funds.

Conservative approach:

Under the conservative approach, the firm finances long-term assets, all permanent current assets, and some temporary current assets with long-term sources of funds. This approach relies more heavily on long-term financing than the other approaches. This involves higher pay back period which involves more interest outflow.

c. Generally, all the approahes have their own advantages and disadvantages. The decision of chosing the approach depends on the circumstances of the entity as to requirement of funds, pay back period etc. But the maturity matching approach can be said to be better as it maintains balance between inflow and outflow of funds.