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Maturity matching approach has various advantages and disadvantages. The biggest advantages are that it maintains an optimum level of funds, saves interest cost, no refinancing risk, and interest rate fluctuation risk. The main disadvantage is its difficulty in implementation.
Maturity matching or hedging approach of working capital financing is an idealistic approach. It is based on the basic principle of finance that long-term asset should be financed with long-term sources of finance such as equity, term loan, debentures etc. and short term assets should be financed with short-term sources of finance such as short-term loans, current liabilities, cash credit, bank overdraft, other working capital loans etc.
Advantages of Matching Maturity Approach
Optimum Level of Funds (Liquidity)
The funds remain on the balance sheet only till they are in use. As soon as they are not needed, they are paid. This is how the interest cost is optimized in this strategy. Interest is paid only for the amount and time for which money is used. There is no unutilized cash lying idle with the business.
Savings on Interest Costs
When short-term requirements are not funded with long-term finances, the firm saves interest rate difference between long term and short term interest rates. It is already known that long-term interest rates are comparatively higher due to the concept of risk premium.
No Risk of Refinancing and Interest Rate Fluctuations during Refinancing
Since the fundamental principle of finance is followed here i.e. long term asset to long-term finance and short term assets to short term finance, there are no risk of refinancing and the interest rate fluctuations during refinancing. This means that while renewing a loan if the market scenario changes, the rate of interest may also adversely change. Here, there is no problem of frequent refinancing.
Disadvantages of Matching Maturity Approach
Difficult to Implement
It is one of the best strategies or ideal strategy but it is very difficult to implement. Exactly matching the maturity of assets with their source of finance is practically not possible. There is quite a lot of uncertainty on current asset’s side. One cannot exactly predict at what time, the debtor will pay or what time the sales will occur. Once the credit is extended, the ball goes in the court of the debtor.
Risks Still Persist
After adopting this strategy and planning everything in accordance with it, if the assets are not realized on time, it will not be possible to extend the loan due dates unreasonably. In that situation, the strategy moves either towards conservative or aggressive approach. Once that happens, the analytics and risks of those strategies will apply. The risks which are avoided with this strategy again come into play.