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

A company needs to finance seasonal working capital, with the need arising for a few months each year and disappearing afterwards. Which form of bank borrowing is generally best suited to this need?

An overdraft facility is best because the company borrows only when seasonal needs arise, pays interest only on the amount drawn, and can repay when cash returns. Long-term loans, debentures, sale and leaseback or preference shares commit the firm to permanent, costlier funding.

  1. AA long-term fixed-rate term loan repaid over ten years
  2. BAn overdraft facility drawn only when neededCorrect
  3. CA sale and leaseback of the head office
  4. DA debenture issue secured on fixed assets
  5. An issue of irredeemable preference shares

Explanation

An overdraft is flexible: interest is charged only on the amount drawn and it can be cleared when the seasonal need ends. A long-term term loan or a debenture would leave the company paying interest and committed when funds are idle. Sale and leaseback and preference shares are long-term and costly for a temporary need.

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