– The nature of short-term finance is that it tends to be risky in the sense of requiring the firm to frequently renew the principal amounts of financing outstanding; this could become a problem during ‘hard times’.
– The rates of return on financing either short or long term activities are best understood by considering the costs of the financing type.
– Interest rates are not the reason for return or cost differences between short or long term finance.
– The costs depend on reversibility differences between the types of finance. In situations where companies find themselves with unforeseen reductions in the need for financing, short-term finance is dispensed with (reversed) quickly at the end of its term.
– Therefore short-term finance is less costly than long-term finance and because lower costs mean higher return, it also exhibits a higher return.
– This is exactly opposite of the risk return characteristic of its assets.