Question

What does it mean to adopt a maturity matching approach to financing assets, including current assets? How would a more aggressive or a more conservative approach differ from the maturity matching approach, and how would each affect expected profits and risk? In general, is one approach better than the others?

Answer 1

The two approach varies and differs.

Step-by-step explanation:

Maturity matching is simply the pitching of the economic benefits derived from utilization of an asset, with the economic cost utilized in bringing the economic benefits. A company is either financed by debt instrument or equity instrument. Unlike equity, debt comes with stated terms on repayment and/or redemption. This is often determined by the maturity dates specified.

Basically, maturity matching specifies that a current asset should be matched with a current liability. In same vein, a non current liabilities should only be earned on a non current asset. Maturity matching matches these in a bid to properly convey the financial true position of the firm.

An aggressive approach, nonetheless, difers from the above in that, a short term loan(overdraft) could be used to finance a long term project- non current asset. A firm might be influenced by the much liquidity available through the short term loan and there by erroneously use such in, say, expansion bid. This is wrong. The loan will be repaid in the shortest period and the firm will thus be challenged with such. The implication with this approach is that it takes a wrong view on the financial position as the cost is not evenly spread. Thus, even though it posted a good liquidity standing, this cannot be taken as final, as the cost implication must be evenly spread throughout the lives of the project. This thus vitiate the integral matching concept in accounting.

A more conservative approach tows the line of the maturity matching approach as it seeks to only incur a non current liability on a long current asset, and a current liability on a current asset. Using this approach thus takes cognizant of other risk elements in business. Cost, earnings and depreciation are thus evenly matched. It thus aid critical financial performance evaluation and also depicts true financial position of as firm. The conservative approach is knowledge based and less riskier on long term sustainability.

Answer 2

Current assets are assets that are used in an organization for its daily transactions and can be easily converted into cash are known as current assets. Inventory, cawasprepaid expenses, and account receivables are some of its types.

Maturity matching is using short term finances or temporary working capital for short term assets and long term finances or permanent working capital for long term assets. If short term funds are used for financing fixed assets, the amount repaid will be much higher and the borrower will face the risk of refinancing, which means he will refinance the loan for a longer period.

Explanation:

Matching maturities causes the cash flows from an asset to be synchronized with the cash costs required for the capital used to finance the assets. If the company was financed only with debt and the debt was amortized, the match would be quite close. However, companies use both debt and equity, and the equity has no stated maturity. Similarly, assets have different lives, and those lives cannot always be determined when the asset is financed.