Introduction to Finance

FIGURE 16.6
Current Liabilities Divided by Total Assets for Selected Firms

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16.2 Factors Aff ecting Short-Term Financing
497
(by Fitch), stood at CC.
4
The rise in short-term fi nancing could be an indication of fi nancial 
duress by the fi rm.
Seasonal Variation 
Our earlier discussion of Figure 16.3 pointed out that seasonal 
variations in sales aff ect the demand for current assets. Inventories are built up to meet sea-
sonal needs, and receivables rise as sales increase. The peak of receivables will come after 
the peak in sales, the amount of intervening time depending on the credit terms and payment 
practices of customers. Accounts payable will increase as inventories are purchased. The dif-
ference between the increase in current assets and accounts payable should be fi nanced by 
short-term borrowing, because the need for funds will disappear as inventories are sold and 
accounts receivable are collected. When a need for additional funds is fi nanced by a short-
term loan, such a loan is said to be self-liquidating since funds are made available to repay it 
as inventories and receivables are reduced.
Sales Trend 
A fi rm’s sales trend aff ects the fi nancing mix. As sales grow, fi xed assets and 
current assets must grow to support the sales growth as depicted in Figure 16.3. This need for 
funds is ongoing unless the upward trend of sales is reversed. 
If asset growth is initially fi nanced by short-term borrowing, the outstanding borrowings 
will continue to rise as sales rise. The amount of debt may rise year by year as the growth trend 
continues upward. After a while, the current ratio will drop to such a level that no fi nancing 
institution will provide additional funds. The only alternative is long-term fi nancing. Long-
term fi nancing often rises to reduce excess levels of short-term fi nancing.
As we will learn later in this chapter, short-term fi nancing can be increased over time in 
small increments, if needed, by applying for loans and negotiating with borrowers, as seen 
in Panel A of 
Figure 16.7
. Long-term external fi nancing, however, is “lumpy.” Because of 
4
See http://www.businesswire.com/news/home/20151118006386/en/Fitch-Affi
rms-Sears-Holdings-CC, accessed 
February 5, 2016.
Panel A: Pattern of Short-Term Financing
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Time
Panel B: Pattern of Long-Term Financing
0
Time
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