How Long Should You Borrow Short Term?

The matching principle of finance states that long-term needs should be financed with long-term capital and temporary needs met by short-term loans. When violating this principle, as smaller businesses often do, an assessment of the risks involved is required. These risks are: 1. interest rate risk,...

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Bibliographic Details
Published in:Harvard business review 1986-03, Vol.64 (2), p.20
Main Author: Viscione, Jerry A
Format: Magazinearticle
Language:English
Subjects:
Capital
Commercial credit
Corporate finance
Investments
Loans
Matching concept
Risk
Short term debt
Short term financing
Small business
Small business loans
Working capital
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Summary:The matching principle of finance states that long-term needs should be financed with long-term capital and temporary needs met by short-term loans. When violating this principle, as smaller businesses often do, an assessment of the risks involved is required. These risks are: 1. interest rate risk, 2. refinancing risk, and 3. risk of the loss of operating autonomy. A business' lender, owners, and managers should together formulate financial policies for working capital. Flexibility, provided by contingency sources of capital and/or an action plan that will free up working capital, is critical to businesses violating the matching principle to ensure the ability to eliminate the short-term debt within a reasonable time without disrupting operations. An inability to raise long-term capital dictates close adherence to the matching principle. Potential sources of long-term capital that will enhance financial flexibility should be explored so that unexpected problems can be handled.
ISSN:0017-8012