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CMA Intermediate · Financial Management and Business Data Analytics · Sources of Finance

Sharma Textiles Ltd needs funds to buy machinery with a useful life of 10 years. Which matching principle of financing is most appropriate?

Long-term funds like a term loan or debentures are most appropriate. Under the matching principle, the tenure of finance should correspond to the life of the asset financed. A ten-year machine funded by short-term sources would need repeated refinancing and expose the firm to liquidity risk.

  1. AFinance it with a bank overdraft repayable on demand
  2. BFinance it with long-term funds such as term loan or debenturesCorrect
  3. CFinance it with trade creditors
  4. DFinance it with 90-day commercial paper

Explanation

The maturity matching (hedging) approach finances fixed assets with long-term funds. Using short-term sources such as overdraft, trade credit or commercial paper for a 10-year asset would create refinancing risk and liquidity strain.

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