The approaches that Blin could accept regarding the relative proportions of long- and short-term finance to meet its working capital needs have been described as moderate, conservative and aggressive.
The assets of a business is able to be divided into current assets and fixed assets where current assets are used up on a regular basis within a single accounting period and fixed assets benefit a business for several accounting periods. Current assets are able to be further divided into permanent current assets and fluctuating current assets. Permanent current assets correspond to the core level of investment in current assets needed for a given level of business activity and occur from the need for businesses to carry inventory and to extend credit. Intermittent current assets represent a variable need for investment in current assets arising from either seasonal or unpredictable variations in business activity.
A conservative approach to the financing mix would accentuate long-term finance as the main source of working capital funds. This approach would utilize long-term finance for permanent current assets, fixed assets and some fluctuating current assets.
Long-term debt finance is fewer risky to a company than short-term debt finance since once in place it isn't subjected to the dangers of renewal or immediate repayment but is more expensive in that the rate of interest charged normally raise with maturity. A conservative approach would consequently increase the amount of lower-risk long-term debt finance used by the company but would as well incur higher total interest payments than an approach emphasizing the use of short-term debt and so would lead to relatively lower profitability. A similar argument is able to be made with reference to equity finance which requires a higher return than long-term debt finance.
An aggressive approach to the financing merge would emphasize short-term finance as the main source of working capital funds. This approach which is at present being used by Blin uses short-term finance for fluctuating current assets and some permanent current assets with long-term finance being used for the balance of permanent current assets and fixed assets.
This raise the relative amount of higher-risk short-term finance used by the company but will as well incur lower total interest payments than the conservative approach discussed above leading to relatively higher profitability.
Among these two approaches lies a moderate or matching approach. This approach relates the matching principle whereby the maturity of the funding is matched with life of the assets financed. Here long-term finance is utilized for permanent current assets and fixed assets while short-term finance is used for fluctuating current assets.
The repayment of the overdraft wills consequence in Blin adopting a conservative approach to the mix of long- and short-term finance. This will determine an overtrading situation if it exists but may reduce profitability more than necessary. If Blin keeps on expanding sales or reintroduces overdraft finance the conservative position will only be temporary and a moderate position may arise in the future. The speed with which this occurs will depend on the size of the loan taken out and whether a moderate position is desirable will depend on the company's attitude to risk and return. It may be preferable to decrease the overdraft to a lower level relatively than repaying it completely. A clearer picture would appear if we knew the intended use for and the amount of the balance of the loan not being used to repay the overdraft.