1. AVER Ltd is considering short term financing for its working capital requirement. You are invited...

Question

1. AVER Ltd is considering short term financing for its working capital requirement. You are invited to provide a discussion on the risk-return trade-off that the company should consider in selecting different sources of short term financing. In your discussion, illustrate with an appropriate example where possible. Write 1,250 words for this question.
Subject learning outcomes
This assessment task will assess the following learning outcome/s:
· be able to identify, analyse and solve financial problems confronting business enterprises, particularly problems relating to corporate investment, asset management and financing decisions.
· be able to employ analytical techniques, using contemporary electronic aids appropriate to financial decision making.
· be able to analyse the impact of economic, legal and tax changes on the financial position of the firm.
· be able to demonstrate critical evaluation and communication skills relating to the scope, methodology, role, objectives and ethics of financial management within business organisations.

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Shakeel · Accepted Answer

Capital is one of the essential requirements for any business. Capital brings assets to the company that generates revenue and profit. There are several short term and long term sources of capital. Long term capitals are used for sustainability and growth of business. Equity capital, preference shares, long term debts etc are some of the prominent examples of long term capital. Short term capitals are used for day to day operation of the business. They are also called working capital. Smooth running of business needs sufficient fund to meet the regular expenses and therefore, company is obliged to meet the specific level every time. 
There are several sources of short term financing. Few of them are Cash, Account payable, Account receivable, short term bank loan, Commercial paper, line of credit, trade credit etc. Every source of funding has its own risk-return trade off and thus, some advantages as well as some disadvantages. Therefore, it is necessary for any business to evaluate properly the nature of its requirement and select the short term source of funding accordingly.
Account receivable is a good source of short term finance. When company sells it products or renders its services on credit to its customers, account receivable is created. It is the total amount that customers owe to the company. Company provides credit to customer according to its credit policy. The main purpose of providing credit is to retain the existing customers with business and increase the sales volume by providing lucrative credit offers. The account receivable is converted into cash after credit period that is decided by the company according to its credit policy. Account receivable is cheapest source of short term finance where company bears the cost of funding at the extent of opportunity cost; arises due to lock-in of fund to customers for credit period. Second, there is risk of band debt. If customers fail to pay the credit amount, company has nothing to do but record that amount as a bad debt in its book. Hence, on one side account receivable provides fund in short time and on the other hand, it is riskier to the extent of bad debt.

1. AVER Ltd is considering short term financing for its working capital requirement. You are invited to provide a discussion on the risk-return trade-off that the company should consider in selecting...

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