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Why does over reliance on short term finance cause liquidity problems as it does in an aggressive working capital financing policy but long term finance does not? Is it because we have more time to repay the money we owe? (Assuming we’re talking about a long term loan and not raising money through shares)
It doesn’t automatically cause liquidity problems, but there is more risk that it will cause liquidity problems. The reason is mainly that the bank can always insist on immediate repayment of the short-term finance (overdraft) if they want to whereas that is not the case with long-term finance (whether it be from long term loans or from shares). In addition, but less importantly, the interest charged on overdraft finance can be increased ‘instantly’ whereas with long-term borrowing the I interest rate is normally fixed.
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