Final Answer:
Permanent working capital financed with short-term debt carries high risk and lower profitability due to interest rate fluctuations and potential refinancing challenges.
Step-by-step explanation:
Financing permanent working capital with short-term debt introduces significant risk. Short-term debt is sensitive to interest rate changes, and fluctuations can lead to increased financing costs, impacting profitability. Additionally, the need for frequent refinancing poses challenges, as economic conditions and credit markets may vary. This exposes the business to uncertainties in securing favorable terms for ongoing operations.
Furthermore, relying on short-term debt for permanent working capital limits financial flexibility. The business may face liquidity issues if market conditions tighten, and lenders become less willing to extend credit. This lack of flexibility can impede strategic decision-making and hinder the company's ability to seize growth opportunities.
In contrast, using long-term financing for permanent working capital provides stability. Long-term debt often comes with fixed interest rates, shielding the business from short-term interest rate volatility. This predictability supports better financial planning and enhances overall profitability by minimizing interest rate risks associated with short-term debt.