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Flip to reveal answersWhat does the matching principle in finance mean?
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All 25 Flashcards — Short-term versus long-term finance
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Question
What does the matching principle in finance mean?
Answer
Match the time period of finance to the life of the asset or the duration of the need.
💡 Hint
Time period must fit.
Question
Short-term finance is for less than ______ year.
Answer
One.
💡 Hint
< 1 year.
Question
State two factors that affect the choice of finance.
Answer
Purpose of finance and cost (interest/fees or dilution). Other factors: time period, risk, business type, amount needed.
💡 Hint
Purpose + cost.
Question
Define long-term finance.
Answer
Long-term finance is funding raised for more than one year, often to fund major investment and growth.
💡 Hint
More than 1 year.
Question
Define short-term finance.
Answer
Short-term finance is funding needed for less than one year, usually to cover day-to-day working capital needs.
💡 Hint
Less than 1 year.
Question
Give two examples of long-term finance.
Answer
Bank loans and share capital (others include retained profit, leasing, mortgages, venture capital).
💡 Hint
Loans + shares.
Question
Give two examples of short-term finance.
Answer
Bank overdraft and trade credit (others include short-term loans and factoring).
💡 Hint
Overdraft + trade credit.
Question
Why is using an overdraft to buy a factory a problem?
Answer
It is short-term finance for a long-term asset; the bank can withdraw it, creating serious liquidity risk.
💡 Hint
Short-term for long-term = risky.
Question
Why does business type matter when choosing finance?
Answer
Sole traders/partnerships cannot issue shares, while limited companies can raise equity through share capital.
💡 Hint
Some sources not available.
Question
Long-term finance is for more than ______ year.
Answer
One.
💡 Hint
> 1 year.
Question
Why is an overdraft suitable for short-term needs?
Answer
It is flexible: the business can borrow only what it needs up to a limit and repay quickly when cash comes in.
💡 Hint
Flexible for cash gaps.
Question
How does risk tolerance affect the choice of finance?
Answer
More debt increases financial risk due to fixed repayments; more equity reduces repayment risk but can reduce control.
💡 Hint
Debt = higher risk.
Question
Give one example of matching finance correctly.
Answer
Using a long-term loan or mortgage to buy a building/factory that will be used for many years.
💡 Hint
Long-term for long-life.
Question
Why is a bank loan suitable for long-term investment?
Answer
Because it provides a large lump sum to buy long-life assets and can be repaid over several years to match the asset’s use.
💡 Hint
Matches long-life assets.
Question
Matching principle: match finance term to the ______ of the asset/need.
Answer
Life.
💡 Hint
Time fit.
Question
What is leasing as a source of long-term finance?
Answer
Leasing is renting an asset for regular payments so the business can use it without buying it outright.
💡 Hint
Use without owning.
Question
Using short-term finance for long-term assets increases ______ risk.
Answer
Liquidity.
💡 Hint
Cash squeeze.
Question
What is factoring?
Answer
Factoring is selling unpaid invoices (trade receivables) to a third party for immediate cash, usually for a fee.
💡 Hint
Sell invoices for cash.
Question
Which source is often best to fund seasonal stock purchases?
Answer
Trade credit or an overdraft, because the need is short-term and the stock is used up quickly.
💡 Hint
Stock = short-term need.
Question
Why is the amount needed important?
Answer
Small short gaps may suit overdrafts/trade credit, while large investments may require loans, share capital or venture capital.
💡 Hint
Small vs large.
Question
When asked to recommend a finance source, what should your final paragraph do?
Answer
Make a clear recommendation and justify it using purpose, time period (matching), cost, risk and control in the case context.
💡 Hint
Recco + justify.
Question
Exam tip: In finance recommendations, always evaluate cost, control and ______.
Answer
Risk.
💡 Hint
Pros/cons in context.
Question
State one risk of relying too much on short-term finance.
Answer
It can be expensive and risky if lenders withdraw facilities; it may create cash flow pressure if repayments are due quickly.
💡 Hint
Short-term pressure.
Question
State one drawback of long-term finance (debt).
Answer
Interest increases total cost and long repayment commitments increase financial risk if revenue falls.
💡 Hint
Long commitment.
Question
What is the key exam skill when recommending a source of finance?
Answer
Justify why the source matches the purpose and time period, and evaluate cost, risk and control in context.
💡 Hint
Justify + evaluate.
Read the notes
Full study notes for Short-term versus long-term finance
Topic 3.2 hub
Sources of finance
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BM exam skills
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