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IAI Actuarial Core Principles · Business Finance · Financial instruments issued or used by companies

A company needs funds to cover a temporary gap between paying suppliers and collecting receipts from customers. Which of the following sources is best matched to this need?

A bank overdraft is best matched, because it is flexible short-term finance with interest only on the balance actually used. Long-term debentures, equity, sale and leaseback or term loans are long-term commitments that suit permanent needs, not a temporary working capital gap.

  1. AA bank overdraft facility with interest charged on the daily outstanding balanceCorrect
  2. BA 15-year fixed-rate debenture issue
  3. CA new issue of equity shares through a rights offer
  4. DA sale and leaseback of the head office building
  5. A 10-year term loan secured on plant

Explanation

Short-term funding gaps are best financed by flexible, short-term sources. An overdraft is repayable on demand and interest is charged only on the amount actually used. Long-term debentures, equity, sale and leaseback and term loans commit the firm to long-term finance for a temporary need and add cost.

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