Acca financial Accounting (FA) Study Text ac ca (FA)

Interest cover  

 

A business must have a sufficient level of long-term capital to finance its 

long-term investment in non-current assets. Part of the investment in 

current assets would usually be financed by relatively permanent capital 

with the balance being provided by credit from suppliers and other short-

term borrowings. Any expansion in activity will normally require a 

broadening of the long-term capital base, without which ‘overtrading’ may 

develop (see below). 

Suitability of finance is also a key factor. A permanent expansion of an 

entity’s activities should not be financed by temporary, short-term 

borrowings. On the other hand, a short-term increase in activity such as 

the ‘January sales’ in a retail trading entity could ideally be financed by 

overdraft. 

A major addition to non-current assets such as the construction of a new 

factory would not normally be financed on a long-term basis by overdraft. 

It might be found, however, that the expenditure was temporarily financed 

by short-term loans until construction was completed, when the overdraft 

would be ‘funded’ by a long-term borrowing secured on the completed 

building. 

 

 

 

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